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Statement on Proposals Related to Equity Market Structure

Dec. 14, 2022

The equity markets are a place where Americans can invest and grow their savings, for everything from retirement, to a child’s education, to buying a new home or taking a well-earned vacation.  In order for the markets to serve this purpose, investors must have confidence in their trading venues and market intermediaries – and this requires well-regulated, well-functioning markets that are efficient, competitive and transparent.  When investors lack confidence in the public equity markets, it may manifest in people seeking out other, riskier investments, such as those offered on the more opaque private and over-the-counter markets, or involving non-compliant crypto entities.

The equity markets are complex and interconnected.  Over time, new technologies, regulations, and other developments have caused the markets to change and evolve, sometimes in unanticipated ways.  In order for the SEC to fulfill its three-part mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation, we must continually re-evaluate our approach to market regulation, making adjustments as needed to respond to changes.  I am pleased that we are taking that responsibility seriously by proposing a package of new rules and rule amendments that is designed to improve outcomes for all investors, and retail investors in particular. 

Public comment is vital to every Commission rulemaking effort, but particularly so here, where the issues are highly complex and technical.  The SEC staff has spent months, and in some cases, years, working on today’s proposals, which are designed to increase competition, transparency, and integrity in the markets.  I look forward to hearing from market participants about whether the approach we are proposing today is the optimal one to achieve those goals, and whether there are changes to the approach, or other approaches, that we should consider.

Amendments to Rule 605

With that introduction, I will now turn to the first proposal before us today, which is designed to update and improve the disclosures that market centers provide about the quality of their executions of investor orders.[1]  Rule 605 requires market centers, such as exchanges, alternative trading systems (ATSs), and broker-dealer internalizers, to make monthly disclosures of standardized information concerning execution quality for orders in National Market System (NMS) stocks.[2]  This can help investors and intermediaries understand what happens to their orders after they are submitted for execution, and how price and other execution quality measures compare across venues. 

Since its adoption over 20 years ago, Rule 605 has provided valuable information about the execution quality offered by different market centers. For many years, however, commenters have noted that the scope and content of Rule 605 reports have not kept pace with changes in the markets.[3]  The amendments we are proposing today would modernize those disclosures by making a number of changes to the scope and content of the reports.  I won’t list them all, as the proposal has been summarized thoroughly by others already, but they include common-sense updates such as the inclusion of odd lots, which are an increasing proportion of orders in today’s markets, and more granular timestamps to reflect the markets’ ever-increasing speed.[4] 

Additionally, the proposal would expand the scope of Rule 605 requirements to include certain large broker-dealers, and would require all covered entities to produce summary reports with aggregated execution quality information.[5]  The summary reports should provide a more digestible source of execution quality information than the full reports, which are lengthy, detailed, and in some cases can be read only with specific processing software.[6] 

I look forward to hearing from commenters about whether the updates we are proposing to make are the right ones, or if there are things we should do differently.  For example, only certain broker-dealers are scoped into the requirements.  Should Rule 605 apply to all broker-dealers, as recommended by the Equity Market Structure Advisory Committee (EMSAC)?[7] Should the creation and formatting of the reports be standardized? Should the reports be made accessible in a central location?  Are the summary reports likely to be helpful to investors?

Thank you to the staff for their work on this proposal.  As you’ve heard already from my colleagues, the staff in the Division of Trading and Markets, the Office of the General Counsel, and the Division of Economic and Risk Analysis have worked incredibly hard to put together the package of proposals we are considering today.  They’ve also had the assistance of staff in Exams, Enforcement, and elsewhere throughout the Commission, and I extend my thanks to everyone who played a part in putting together this package.   The amendments to Rule 605 would make common-sense updates to execution quality disclosures to make them more useful for investors, and I am pleased to support the proposal.

Tick Size, Access Fees, Odd Lots and Round Lots

Thank you, Chair Gensler.  As you’ve heard already from my colleagues, this proposal has three main components: varying and lowering the minimum pricing increments, or “tick sizes,” for quotes and trades in certain NMS stocks, reducing the access fee caps and increasing fee transparency for exchanges, and improving the dissemination of information about smaller orders.[8]

When Congress amended the Exchange Act in 1975, it underscored the public’s interest in benefitting from “fair competition…among exchange markets, and between exchange markets and markets other than exchange markets.”[9]  Fair competition requires entities performing similar functions to be regulated similarly, and extending the minimum tick size to trades executed in non-exchange markets, namely ATSs and off-exchange wholesalers, should help provide a more level playing field across venues. 

With respect to the specific pricing increments in the proposal, many market participants have suggested that trading in tick-constrained stocks would benefit from a smaller minimum tick size, though the specifics of the suggestions have varied.[10]  There are tradeoffs to lowering the minimum tick size – while it allows for more efficient pricing, a smaller tick size also adds complexity and can increase the likelihood that a market participant “jumps the queue” by posting an economically trivial price improvement to get ahead of other orders on the exchange.[11]  Commenter feedback will be vital to ensuring that the minimum tick sizes strike the right balance between those competing concerns.

The second set of proposed changes involves access fees for protected quotations.  The current caps on access fees were adopted 17 years ago, and were designed to prevent fees from constituting an excessive percentage of the share price.[12]  However, the markets have evolved dramatically during the intervening time, and the fee caps have not been updated to reflect lower transaction and trading costs.  Furthermore, as my colleagues have explained, the changes to the minimum tick size make updating the access fees more urgent, because if the fees stay the same while the minimum tick size is reduced, the fees become a greater portion of the cost of executing a trade and can undermine price transparency.[13]

In addition to lowering the fee caps, the proposal would require that all exchange fees and rebates be determinable at the time an order is executed.[14]  In recent years, the exchanges have developed complex fee and rebate schedules, many of which include tiers or other incentives based on a broker-dealer’s trading volume.  One of the many issues with this problematic model is that because the fees are calculated based on monthly volume, broker-dealers and their customers do not actually know what the fees are until after the month’s end.[15]  This uncertainty has implications for transparency and best execution analyses.  Transparency at the time of execution should help broker-dealers make better order routing decisions, and could facilitate a broker-dealer’s ability to pass through the fee or rebate associated with a transaction. This is a model that some customers may prefer, but which is difficult to implement at present, in part due to fee uncertainty. It should also help customers gain insight into whether a broker-dealer may be routing to certain venues based on the fee and/or rebate that venue assesses. 

While this change has the potential to mitigate certain issues around volume-based fees and rebates, I continue to have deep concerns about the model more generally.  From a competitive standpoint, volume-based pricing subsidizes bigger broker-dealer firms at the expense of smaller and mid-sized firms, making it difficult for the smaller players to compete.[16]  From an investor protection standpoint, the need to qualify for a given tier may influence a broker-dealer’s routing decisions at the expense of seeking the best execution for a customer.[17]   These issues may be lessened, but are unlikely to be eliminated, through added transparency.  I believe my concerns in this area are shared by some of my colleagues, and I look forward to working with them to address this issue more comprehensively.

Turning to the last set of changes, odd-lot quotes in higher priced stocks frequently offer prices that are better than the round lot NBBO.[18]  However, information about these orders is currently excluded from core market data, meaning that investors may be missing out on the opportunity for a better price.  The last set of proposed changes in this release accelerate and build upon certain common-sense changes that the Commission adopted as part of the Market Data Infrastructure rulemaking.[19]  Since that package was finalized, and as the SEC has worked towards its implementation, individual share prices have continued to increase, and odd-lot quoting and trading rates have remained high, particularly for higher priced stocks.[20]

The proposed changes – the reduction of the round lot size, the inclusion of odd lot information in core market data, and the creation of a best odd-lot order data element – will help investors take advantage of this better-priced liquidity that is available in the markets.  As of June 2022, odd-lot volume as a proportion of total exchange-traded volume was approximately 19% for all corporate stocks and approximately 7% for all ETPs, higher than the levels observed in the data from 2018 and 2019.[21]  Given the increasing prevalence of odd lot orders in the markets, I believe these are common-sense changes that are long overdue.

Thank you again to the staff who worked on this rule – which is really three rules, so I’ll extend my triple thanks to this team.  And thank you in advance to all those who will submit comments, in particular with respect to the optimal minimum quoting and trading increments.  I look forward to the comments.

Order Competition Rule

As I noted earlier, the equity markets are incredibly complex and interconnected.  In recent decades, a combination of new technologies, regulatory changes, and other developments have transformed trading in NMS stocks.  As recently as 2005, the New York Stock Exchange executed almost 80% of the consolidated share volume in its listed stocks.[22] By 2009, that share had shrunk to 25%.[23]  Today, very little retail order flow is executed on an exchange. Instead, more than 90% of marketable orders by retail investors are routed to a small group of off-exchange wholesalers.[24]  And the wholesaling business is highly concentrated – two firms accounted for 66% of the executed share volume in the first quarter of 2022.[25]  Staff analysis, relying in part on data from the Consolidated Audit Trail, or CAT, has shown that retail broker-dealers accepting payment for order flow, which is often a feature of this type of off-exchange trading, is associated with worse execution quality for their customers.[26] It also showed that while wholesalers often provide price improvement as compared to the NBBO, there is frequently even better-priced midpoint liquidity available on exchanges.[27]

Whatever your feelings about the merits and drawbacks of the current retail trading model, it represents an enormous change to how stocks are bought and sold.  And the levels of concentration and relative lack of competition and transparency raise serious questions about investor protection and investor outcomes. As I noted earlier, in order for the SEC to fulfill its three-part mission, it is imperative that we continually re-evaluate our approach to market regulation.  That is what we are doing today as we consider this package.

This proposal, in particular, is designed to make the trading of NMS stocks more competitive, transparent, and efficient, for the benefit of investors, and in particular, retail investors.  As you’ve heard, the rule would require that certain orders of individual investors be exposed to competition in fair and open auctions, before such orders could be executed internally off-exchange. The details of the proposal have been well-summarized by my colleagues, so I won’t repeat them.  I am supportive of the proposal because I am deeply concerned about the lack of transparency, competition, and the high level of concentration that has become a feature of retail trading in the equity markets, and I believe that the Commission has an obligation to address those issues.  However, I am also acutely aware that, any time the rules that govern the markets change in a significant way, there is a risk of unintended consequences.  I hope that commenters will help us understand what these might be, and let us know whether this approach is the best one to achieve our aims.  For example, there are a number of alternatives discussed in the release.  Could one of those achieve the aims of the rule with fewer costs or less complexity?  Are there drawbacks to the proposed approach that are not addressed in the release? Do commenters have data or other information that could help us consider these questions? I thank the commenters in advance for their feedback.

And of course, I am very thankful to the staff in the Division of Trading and Markets for their hard work and expertise, the staff in the Division of Economic and Risk Analysis who performed extensive data analysis in support of the proposal, and the staff in the Office of the General Counsel who have worked diligently to review all of today’s releases.  Thank you.

Regulation Best Execution

A market intermediary’s duty of best execution is a cornerstone of our investor protection regime.  When applied to a broker-dealer, the duty of best execution requires execution of customers’ trades at the most favorable terms reasonably available under the circumstances.[28]  The idea that a market intermediary must seek the best deal for its customers is fundamental to ensuring that investors can have confidence when they engage in the markets.  And as I noted earlier, without investor confidence, the markets cannot serve their purpose as a place for investors to grow their savings while providing companies with needed capital.

The changes to market structure that we have discussed at length today also have implications for best execution.  In particular, the rise of order incentives like payment for order flow and exchange rebates can create conflicts of interest between a broker-dealer and its customer.  And the proliferation of execution venues has increased market complexity, complicating broker-dealers’ routing decisions. 

While FINRA and the MSRB have for many years had rules and guidance in place addressing the duty of best execution, the SEC has never established its own comprehensive and detailed best execution requirements.[29]  If adopted, the proposal should help provide consistency and clarity with respect to the duty of best execution, while also updating that duty in two key ways: by setting elevated standards applicable to the conflicted transactions that are a common feature of retail trading today;[30] and by better reflecting the role of the introducing broker.[31]  In my view, establishing these more detailed requirements at the SEC level is a long-overdue step that should improve oversight and investor outcomes. 

Given the fundamental importance of the duty of best execution to investor protection, I am interested in whether commenters believe we can or should further strengthen the rules. For example, with respect to the heightened standards for conflicted transactions, should those be limited to retail trades, as proposed, or should they apply to trades for institutional customers as well?  Should the requirements for conflicted transactions apply to all transactions?  Do the proposed requirements provide too much flexibility to broker-dealers in designing and applying their policies and procedures? I thank you in advance for your feedback on these and other questions in the release.

Finally, I will extend my thanks to all the staff who worked on this release, and one last time to the all the staff who worked on this package of proposals.  These proposals represent an incredible amount of effort by the hard-working and talented staff of the SEC, who have truly gone above and beyond.  I wish all of you a very happy, and hopefully restful, holiday season.  Thank you again.


[1] Disclosure of Order Execution Information, Release No. 34-96493 (Dec. 14, 2022).

[2] 17 CFR 242.605.

[4] Disclosure of Order Execution Information, Release No. 34-96493 (Dec. 14, 2022).

[5] Id. at 159-171.

[6] Id. at 204.

[9] 15 U.S.C. 78k-1(a)(1)(C)(ii).

[10] See Regulation NMS: Minimum Pricing Increments, Access Fees, and Transparency of Better Priced Orders, Release No. 34-96494 (Dec. 14, 2022) at Section II.E (summarizing various proposals).

[11] Id. at 167.

[12] Id. at 92.

[13] Id. at 100.

[14] Id. at 106-109.

[15] Id. at 106-107.

[16] See, e.g., Healthy Markets Association, Letter to Gary Gensler re: Transaction Pricing Practices (November 16, 2022).

[17] Id.

[19] Market Data Infrastructure, Release No. 34-90610 (Dec. 9, 2020).  While the SEC’s implementation efforts are ongoing with respect to the MDI rules, implementation hinges in part on the relevant self-regulatory organizations submitting amendments to the existing Consolidated Tape Association (CTA) plan that are consistent with the rule and meet the Commission’s standard for approval.  See Regulation NMS: Minimum Pricing Increments, Access Fees, and Transparency of Better Priced Orders, Release No. 34-96494 (Dec. 14, 2022) at 116-19. Because they have not yet done so, implementation has been delayed. 

[21] Id.

[22] See Concept Release on Equity Market Structure, Release No. 34-61358 (Jan. 14, 2010) at 6.

[23] Id.

[24] Order Competition Rule, Release No. 34-96495 (Dec. 14, 2022) at 6.

[25] Id. at 6-7.

[26] Id. at 237.

[27] Id. at 272-76.

[28] See Regulation NMS, Release No. 34-51808 (June 9, 2005) at 160.  See also Geman v. SEC, 334 F.3d 1183, 1186 (10th Cir. 2003) (“[T]he duty of best execution requires that a broker-dealer seek to obtain for its customer orders the most favorable terms reasonably available under the circumstances.”); Kurz v. Fidelity Management & Research Co., 556 F.3d 639, 640 (7th Cir. 2009) (describing the “duty of best execution” as “getting the optimal combination of price, speed, and liquidity for a securities trade”).

[29] Regulation Best Execution, Release No. 34-XXXXX (Dec. 14, 2022) at 6-7.

[30] Id. at 124-131.

[31] Id. at 153-175.

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