# Disclosure of Order Handling Information > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2018-24423 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** November 19, 2018 - **Citation:** 83 FR 58338 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 240 and 242 [Release No. 34-84528; File No. S7-14-16] RIN 3235-AL67 Disclosure of Order Handling Information AGENCY: Securities and Exchange Commission. ACTION: Final rule. SUMMARY: The Securities and Exchange Commission (“Commission” or “SEC”) is adopting amendments to Regulation National Market System (“Regulation NMS”) under the Securities Exchange Act of 1934 (“Exchange Act”) to require additional disclosures by broker-dealers to customers regarding the handling of their orders. The Commission is adding a new disclosure requirement which requires a broker-dealer, upon request of its customer, to provide specific disclosures related to the routing and execution of the customer's NMS stock orders submitted on a not held basis for the prior six months, subject to two de minimis exceptions. The Commission also is amending the current order routing disclosures that broker-dealers must make publicly available on a quarterly basis to pertain to NMS stock orders submitted on a held basis, and the Commission is making targeted enhancements to these public disclosures. In connection with these new requirements, the Commission is amending Regulation NMS to include certain newly defined and redefined terms that are used in the amendments. The Commission also is amending Regulation NMS to require that the public order execution report be kept publicly available for a period of three years. Finally, the Commission is adopting conforming amendments and updating cross-references as a result of the rule amendments being adopted in this rule. DATES: Effective date: January 18, 2019. Compliance date: May 20, 2019. FOR FURTHER INFORMATION CONTACT: Theodore S. Venuti, Assistant Director, at (202) 551-5658, Steve Kuan, Special Counsel, at (202) 551-5624, Sarah Albertson, Special Counsel, at (202) 551-5647, Michael Bradley, Special Counsel, at (202) 551-5594, Amir Katz, Special Counsel, at (202) 551-7653, Emerald Greywoode, Special Counsel, at (202) 551-7965, or Andrew Sherman, Special Counsel, at (202) 551-7255, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549. SUPPLEMENTARY INFORMATION: The Commission is adopting: (1) Amendments to 17 CFR 242.600 and 242.606 (respectively, “Rule 600” and “Rule 606” of Regulation NMS) under the Exchange Act to require additional disclosures by broker-dealers to customers about the routing of their orders; (2) amendments to 17 CFR 242.605 (“Rule 605” of Regulation NMS) to require that the public order execution reports be kept publicly available for a period of three years; and (3) conforming changes and updated cross-references in 17 CFR 240.3a51-1(a) (“Rule 3a51-1(a) under the Exchange Act”), 17 CFR 240.13h-1(a)(5) (“Rule 13h-1(a)(5) of Regulation 13D-G”), 17 CFR 242.105(b)(1) (“Rule 105(b)(1) of Regulation M”), 17 CFR 242.201(a) and 242.204(g) (“Rules 201(a) and 204(g) of Regulation SHO”), 17 CFR 242.600(b), 242.602(a)(5) and 242.611(c) (“Rules 600(b), 602(a)(5), and 611(c) of Regulation NMS”), and 17 CFR 242.1000 (“Rule 1000 of Regulation SCI”). Table of Contents I. Introduction II. Overview of Adopted Rule Amendments III. Amendments to Rule 600, Rule 605, and Rule 606 A. Customer-Specific Order Handling Reports 1. Applicability of Customer-Specific Disclosures in Rule 606(b) 2. Definition of Actionable Indication of Interest 3. Scope of Broker-Dealer's Obligation Under Rule 606(b)(3) 4. Timing and Frequency Requirements for Customer-Specific Order Handling Report 5. Format of Customer-Specific Order Handling Reports 6. Rule 606(b)(3) Report Content 7. Rule 606(c) Quarterly Aggregated Public Report of Rule 606(b)(3) Information B. Public Order Routing Report Under Rule 606(a) 1. Orders Covered By Rule 606(a) Public Disclosures 2. Marketable Limit Orders and Non-Marketable Limit Orders 3. Payment for Order Flow Disclosures—Rules 606(a)(1)(iii) and (iv) 4. Format of Public Order Routing Report 5. Division of Rule 606(a) Report's Section on NMS Stocks by S&P 500 Index and Other NMS Stocks 6. Calendar Month Breakdown 7. Execution Metrics C. Amendment to Disclosure of Order Execution Information IV. Paperwork Reduction Act A. Summary of Collection of Information 1. Customer-Specific Disclosures Under Rule 606(b)(3) 2. Amendment to Current Public and Customer-Specific Disclosures 3. Amendment to Current Disclosures Under Rule 605 B. Use of Information 1. Customer-Specific Disclosures Under Rule 606(b)(3) 2. Amendment to Current Public and Customer-Specific Disclosures 3. Amendment to Current Disclosures Under Rule 605 C. Respondents 1. Initial Estimate 2. Estimate for Adopted Rule [Amendments to 605 and 606] D. Total Initial and Annual Reporting and Recordkeeping Burdens 1. Customer-Specific Disclosures Under Rule 606(b)(3) 2. Proposed Public Aggregated Report on Orders Subject to the Customer-Specific Disclosures Under Rule 606(b) Not Adopted 3. Proposed Requirement to Document Methodologies for Categorizing Order Routing Strategies Not Adopted 4. Amendment to Current Public and Customer-Specific Disclosures 5. Revisions to Compliance Manuals 6. Amendment to Disclosures Under Rule 605 E. Collection of Information Is Mandatory F. Confidentiality of Responses to Collection of Information G. Retention Period for Recordkeeping Requirements V. Economic Analysis A. Introduction B. Baseline 1. Current $200,000 Threshold 2. Current Reporting for NMS Stock Orders of $200,000 and Above 3. Publication Period for Reports Required by Rules 605 and 606 4. Available Information on Conflicts of Interest 5. Available Information on Execution Quality 6. Format of Current Reports 7. Quality of Broker-Dealer Routing Practices for Not Held NMS Stock Orders 8. Use of Actionable IOIs 9. Competition, Efficiency, and Capital Formation C. Costs and Benefits 1. Customer-Specific Order Handling Disclosures 2. Public Order Handling Report 3. Disclosure of Order Execution Information 4. Structured Format of Reports 5. Other Definitions in Adopted Amendments to Rule 600 D. Alternatives Considered 1. Alternative Scope for the Customer-Specific Reports 2. Scope of Broker-Dealer's Obligation Under Rule 606(b)(3) 3. Public Availability of Aggregated Rule 606(b)(3) Order Handling Information 4. Automatic Provision of Customer-Specific Not Held Order Handling Report (Adopted Rule 606(b)(3)) 5. Submission to the Commission of Not Held NMS Stock Order Handling Reports (Adopted Rule 606(b)(3)) 6. Categories of NMS Stocks for Rule 606(a) 7. Disclosure of Additional Information About Not Held NMS Stock Order Routing and Execution 8. Order Handling Reports at the Stock Level (Adopted Rule 606(b)(3)) 9. Alternative to Three-Year Posting Period (Adopted Amendments to Rules 605(a)(2) and 606(a)(1)) E. Economic Effects and Effects on Efficiency, Competition, and Capital Formation 1. Effects of Adopting Amendments on Efficiency and Competition 2. Effects of Adopting Amendments on Capital Formation VI. Regulatory Flexibility Certification VII. Statutory Authority and Text of the Proposed Rule Amendments I. Introduction In July 2016, the Commission proposed to amend Rules 600 and 606 under Regulation NMS to require additional disclosures by broker-dealers to customers about the handling of their orders, to amend Rules 605 and 607 for consistency with the proposed amendments to Rule 606, and to amend other rules to update cross references as appropriate. 1 As discussed below, after careful review and consideration of the comments received, the Commission is adopting these amendments with certain modifications. 1 See Securities Exchange Act Release No. 78309, 81 FR 49432 (July 27, 2016) (“Proposing Release” or “Proposal”). Transparency has long been a hallmark of the U.S. securities markets, and the Commission continuously strives to ensure that investors are provided with timely and accurate information needed to make informed investment decisions. In recent years, the Commission and its staff have undertaken a number of reviews of market structure and market events, and much of this effort has aimed to enhance transparency for investors. 2 The amendments being adopted today to Rule 606 of Regulation NMS represent the Commission's continued commitment to enhance transparency for investors. 2 The Commission recently adopted amendments to Regulation ATS that enhance the operational transparency of alternative trading systems (“ATSs”) that transact in National Market System (“NMS”) stocks (“NMS Stock ATSs”). See Securities Exchange Act Release No. 83663 (July 18, 2018), 83 FR 38768 (August 7, 2018) (“ATS-N Adopting Release”). In addition, the Commission has proposed a Transaction Fee Pilot for NMS stocks to help inform the Commission, market participants and the public about the effects, if any, that transaction-based fees and rebates may have on order routing behavior, execution quality, and market quality. See Securities Exchange Act Release No. 82873 (March 14, 2018), 83 FR 13008 (March 26, 2018) (“Transaction Fee Pilot Proposing Release”). Rule 606 encourages competition by enhancing the transparency of broker-dealer order handling and routing practices. 3 Rule 606(a) requires broker-dealers to provide a publicly available quarterly report of information regarding routing of non-directed orders. 4 Rule 606(b) requires broker-dealers to provide customers, upon request, certain information about the routing of their orders. Prior to the amendments being adopted today, the Rule 606(a) requirements applied to smaller dollar-value orders more typical of retail investors but did not apply to large dollar-value orders more typical of institutional investors. 5 As discussed in detail in the Proposing Release, equity market structure, as well as order handling and routing practices, have changed significantly since Rule 606 was adopted in 2000, presenting a need to update the rule such that it provides transparency into broker-dealer order handling and routing practices that continues to be useful in today's automated and vastly more complex national market system. 6 3 See Securities Exchange Act Release No. 61358 (January 14, 2010), 75 FR 3594, 3602 (January 21, 2010) (“Concept Release on Equity Market Structure”). 4 A “non-directed order” means any customer order other than a directed order. See 17 CFR 242.600(b)(48). A “directed order” means a customer order that the customer specifically instructed the broker-dealer to route to a particular venue for execution. See 17 CFR 242.600(b)(19). As discussed below, these definitions are being revised in connection with the amendments to Rule 606 so that they no longer only apply to “customer orders,” but otherwise are remaining the same. See infra Section III.A.1.b.vii. 5 The Commission limited the scope of Rule 606(a) to smaller dollar-value orders by defining a “customer order” to which the rule applied as an order to buy or sell an NMS security that is not for the account of a broker-dealer, but not any order for a quantity of a security having a market value of at least $50,000 for an NMS security that is an option contract and a market value of at least $200,000 for any other NMS security. See 17 CFR 242.600(b)(18). 6 See Proposing Release, supra note 1, at 49433-44 for a detailed description of the history and the market developments leading to the Proposal. As the Commission noted when it originally adopted Rule 606, in a fragmented market “the order routing decision is critically important” and “must be well-informed and fully subject to competitive forces,” 7 and, further, the public disclosure of order routing practices “could provide more vigorous competition on . . . order routing performance.” 8 By updating the Rule 606 disclosure regime, the rule as amended will provide disclosures more relevant to today's marketplace that encourage broker-dealers to provide effective and competitive order handling and routing services, and that improve the ability of their customers to determine the quality of such broker-dealer services. 9 7 See Securities Exchange Act Release No. 43590 (November 17, 2000), 65 FR 75414, 75415 (December 1, 2000) (“Rule 606 Predecessor Adopting Release”). For clarity, when this release references “Predecessor Rule 606,” it is referring to the version of the rule adopted in the Rule 606 Predecessor Adopting Release. 8 See id. at 75417. 9 If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. II. Overview of Adopted Rule Amendments To facilitate enhanced transparency regarding broker-dealers' handling and routing of orders in NMS stock, the Commission proposed to amend Rules 600(b) and 606 such that all orders of any dollar value in NMS stock 10 submitted by a customer to a broker-dealer would be covered by order handling and routing disclosure rules. Under the proposed amendments, new Rule 606(b)(3) would require broker-dealers to make detailed, customer-specific order handling disclosures for NMS stock orders available to institutional customers in particular, who previously were not entitled to disclosures under the rule for their order flow, or were entitled to disclosures that have become inadequate in today's highly automated and more complex market. 11 The Commission also proposed to require a broker-dealer to make publicly available a report that aggregates the information required for the detailed customer-specific order handling reports for all NMS stock orders that it receives across all of its customers. 12 Further, the Commission proposed updating Rule 606(a) to provide retail customers in particular with certain enhanced disclosures regarding a broker-dealer's order routing practices. 13 10 “NMS stock” and “NMS security” are defined in Rule 600 of Regulation NMS. See 17 CFR 242.600(b)(46)-(47). 11 See proposed Rule 606(b)(3); see also Proposing Release, supra note 1, at 49447. 12 See proposed Rule 606(c); see also Proposing Release, supra note 1, at 49447. 13 See proposed Rule 606(a); see also Proposing Release, supra note 1, at 49462. The Commission received comments on the Proposal. 14 The commenters, many of which also commented on Rule 606 in connection with the Concept Release on Equity Market Structure, overwhelmingly supported updating the disclosures required by Rule 606. Most also expressed support for, or offered constructive critiques of, specific components of the Proposal, and several suggested alternatives to specific provisions of the Proposal, but all comments received recognized a need for enhanced transparency and supported the goals of the Proposal. 15 In addition, the Equity Market Structure Advisory Committee (“EMSAC”) provided recommendations with respect to Rules 605 and 606 on November 29, 2016, to provide meaningful execution quality and order handling disclosures from a retail and an institutional perspective. 16 14 Comments received on the Proposal are available on the Commission's website, available at https://www.sec.gov/comments/s7-14-16/s71416.htm . 15 See, e.g., Letter from John A. McCarthy, General Counsel, KCG Holdings, Inc., dated October 31, 2016 (“KCG Letter”) at 1; Letter from Joseph Kinahan, Managing Director, Client Advocacy and Market Structure, TD Ameritrade, Inc., dated October 18, 2016 (“Ameritrade Letter”) at 1; Letter from Tyler Gellasch, Executive Director, Healthy Markets Association, dated September 26, 2016 (“HMA Letter”) at 3-4; Letter from Micah Hauptman, Financial Services Council, Consumer Federation of America, dated September 26, 2016 (“CFA Letter”); Letter from Stuart J. Kaswell, Executive Vice President and Managing Director, General Counsel, Managed Funds Association, dated September 23, 2016 (“MFA Letter”) at 1. 16 See EMSAC Recommendations Regarding Modifying Rule 605 and Rule 606 (“EMSAC Rule 606 Recommendations”), November 29, 2016, available at https://www.sec.gov/spotlight/emsac/emsac-recommendations-rules-605-606.pdf . After careful review and consideration of the comment letters and upon further consideration by the Commission concerning how to further the goal of more useful and effective disclosure of order handling information under Regulation NMS, the Commission is adopting the proposed amendments to Rules 600 and 606 (and the other corresponding proposed amendments) with certain modifications. 17 17 The amendments to Rule 606 would not limit any other obligations that broker-dealers may have under applicable federal securities laws, rules, or regulations, including the anti-fraud provisions of the federal securities laws. Specifically, the Commission is amending Rule 606(b) of Regulation NMS 18 to require a broker-dealer, upon request of a customer that places, directly or indirectly, one or more orders in NMS stock that are submitted on a “not held” basis with the broker-dealer, 19 to provide customer-specific disclosures, for the prior six months, broken down by calendar month, regarding: (1) Its internal handling of such orders; (2) its routing of such orders to various trading centers; 20 (3) the execution of such orders; and (4) the extent to which such orders provided liquidity or removed liquidity, and the average transaction rebates received or fees paid by the broker-dealer. 21 Generally, the information is available upon request by customers who submitted “not held” NMS stock orders through the broker-dealer, and is required to be provided for each venue and divided into separate sections for directed orders and non-directed orders. 22 This new disclosure requirement is subject to two de minimis exceptions. 23 A “not held” NMS stock order that is subject to either de minimis exception is covered by the existing customer-specific disclosures in Rule 606(b)(1), as is any “held” NMS stock order submitted by a customer to any broker-dealer. 24 For the reasons explained below, the Commission is not adopting the proposed requirement that the Rule 606(b)(3) disclosures be divided into passive, neutral, and aggressive order routing strategies. 18 17 CFR 242.606(b). 19 Typically, a “not held” order provides the broker-dealer with price and time discretion in handling the order, whereas a broker-dealer must attempt to execute a “held” order immediately. 20 A “trading center” is defined in Rule 600 of Regulation NMS. See 17 CFR 242.600(b)(78). 21 See Rule 606(b)(3). 22 See id. 23 See Rules 606(b)(4) and (b)(5). 24 See Rule 606(b)(1). As discussed below, while the amendments to Rule 606(b)(1) modify the orders that are covered by Rule 606(b)(1), the required disclosures under Rule 606(b)(1) are not changing. See infra Section III.A.1.b.vi. In connection with the new disclosure requirement, the Commission is amending Rule 600(b) of Regulation NMS 25 to include definitions of the terms “actionable indication of interest,” “orders providing liquidity,” and “orders removing liquidity,” and to revise the existing definitions of the terms “directed order” and “non-directed order.” 26 The Commission is not adopting the proposed defined term “institutional order” in Rule 600(b) and therefore also is not adopting the proposed $200,000 market value threshold for orders to qualify for the new customer-specific disclosures in Rule 606(b)(3). 27 25 17 CFR 242.600(b). 26 The newly defined terms are being incorporated into Rule 600(b) in alphabetical order, in keeping with Rule 600(b)'s existing alphabetical organization of the terms defined therein, and the numbered provisions for existing defined terms in Rule 600(b) are being adjusted accordingly. For ease of reference however, throughout this release, citations to pre-existing defined terms in Rule 600(b) are to their pre-existing numbered provisions, unless otherwise indicated. 27 See Rule 606(b)(3); see also infra Section III.A.1.b.ii. Relatedly, the Commission also is not amending Rule 600(b) to rename the term “customer order” as “retail order,” as was proposed. As discussed in Section III.A.7, infra, the Commission is not adopting the proposed amendment to Rule 606 of Regulation NMS to require a broker-dealer to make publicly available, on an aggregate basis, the order handling information required under Rule 606(b)(3). 28 28 See proposed Rule 606(c). Because the Commission is not adopting proposed Rule 606(c), pre-existing Rule 606(c), which addresses “Exemptions” from the rule and which the Commission proposed to renumber as Rule 606(d) under the Proposal, is not being renumbered as such and remains unchanged as Rule 606(c). The Commission is amending Rule 606(a) of Regulation NMS such that the aggregated order routing disclosures that broker-dealers must make publicly available on a quarterly basis pertain to orders of any dollar value in NMS stock that are submitted on a “held” basis. Further, the Commission is making targeted enhancements to these public disclosures to: (1) Require limit order information to be split into marketable and non-marketable categories (relatedly, the Commission is adopting a definition of the term “non-marketable limit order” under Rule 600(b)); 29 (2) require more detailed disclosure of the net aggregate amount of any payments received from or paid to certain trading centers; (3) require broker-dealers to describe any terms of payment for order flow arrangements and profit-sharing relationships with certain venues that may influence their order routing decisions; and (4) require that broker-dealers keep the order routing reports posted on a website that is free and readily accessible to the public for a period of three years from the initial date of posting on the website. 30 In addition to what was proposed, the Commission is replacing the Rule 606(a) requirement to group order routing information for NMS stocks by listing market with a requirement to group such information by stocks included in the S&P 500 Index as of the first day of the quarter and other NMS stocks. 29 A “marketable limit order” is any buy order with a limit price equal to or greater than the national best offer at the time of order receipt, or any sell order with a limit price equal to or less than the national best bid at the time of order receipt. 17 CFR 242.600(b)(39). “National best bid and national best offer” is defined in Rule 600 of Regulation NMS. 17 CFR 242.600(b)(42). The Commission is adopting new Rule 600(b)(54) to define “non-marketable limit order” to mean “any limit order other than a marketable limit order,” as discussed in more detail below. See infra Section III.B.2. 30 See Rule 606(a); see also Proposing Release, supra note 1, at 49462. “Payment for order flow” has the meaning provided in 17 CFR 240.10b-10. See 17 CFR 242.600(b)(54). A “profit-sharing relationship” is defined in Rule 600 of Regulation NMS. See 17 CFR 242.600(b)(56). Finally, consistent with the amendments to Rule 606(a), the Commission is amending Rule 605 to require market centers 31 to keep execution reports required by the rule posted on a website that is free and readily accessible to the public for a period of three years from the initial date of posting on the website. The Commission also is adopting amendments to other rules to update cross-references in connection with the other rule amendments being adopted today. 32 31 A “market center” means any exchange market maker, OTC market maker, alternative trading system, national securities exchange, or national securities association. See 17 CFR 242.600(b)(38). 32 The Commission is adopting amendments to: Rule 3a51-1(a) under the Exchange Act; Rule 13h-1(a)(5) of Regulation 13D-G; Rule 105(b)(1) of Regulation M; Rules 201(a) and 204(g) of Regulation SHO; Rules 600(b), 602(a)(5), and 611(c) of Regulation NMS; and Rule 1000 of Regulation SCI. Consistent with the Proposal, the Commission continues to believe that generally requiring more detailed, standardized, baseline order handling information to be made available to customers upon request for orders in NMS stocks should enable those customers—and particularly institutional customers—to more effectively assess how their broker-dealers are carrying out their best execution obligations and the impact of their broker-dealers' order routing decisions on the quality of their executions, including the risks of information leakage and potential conflicts of interest. 33 In addition, the Commission believes that these more detailed customer-specific disclosures will further encourage broker-dealers to minimize information leakage, 34 as well as better enable customers to verify that their broker-dealers are following their order handling instructions. Unlike the Proposal and in response to commenters' feedback, the Commission believes that the applicability of these new order routing disclosures should be based on order type (“not held” orders in NMS stocks) rather than the dollar value of an order. 33 See infra Section III.A; see also Proposing Release, supra note 1, at 49434. 34 See id. Similar to the Proposal, the Commission believes that simplifying and enhancing the current publicly available disclosures, particularly with respect to financial inducements from trading centers, should assist customers in evaluating better the order routing services of their broker-dealers and how well they manage potential conflicts of interest. 35 Unlike the Proposal and in response to commenters' feedback, the Commission believes that this goal would be targeted more effectively by having these disclosures apply to “held” orders in NMS stocks rather than those under $200,000. 35 See Proposing Release, supra note 1, at 49434. III. Amendments to Rule 600, Rule 605, and Rule 606 Section III discusses in detail the adopted rule amendments. Subsection A addresses the customer-specific order handling disclosures required by new Rule 606(b)(3) and amended Rule 606(b)(1). This section also discusses a part of the Proposal we are not adopting: Proposed Rule 606(c)'s requirement that broker-dealers make publicly available an aggregated report of the Rule 606(b)(3) customer-specific order handling information across all of their customers. Subsection B addresses the enhanced public report required under amended Rule 606(a). The newly defined and re-defined terms that the Commission is adopting in Rule 600 in connection with the amendments to Rule 606 are discussed where relevant in subsections A and B. The adopted amendment to Rule 605 is discussed in subsection C. The staff will review these amendments, including in particular the de minimis exceptions described in Section III.A.1.b.iv below, not later than one year after the compliance date of the amendments, and report to the Commission. A. Customer-Specific Order Handling Reports 1. Applicability of Customer-Specific Disclosures in Rule 606(b) a. Proposal The Commission proposed to delineate the types of orders that would trigger a broker-dealer's obligation to provide a customer with the order handling disclosures required by new Rule 606(b)(3) by amending Rule 600(b) to include a definition of “institutional order.” 36 Specifically, the Commission proposed to define an “institutional order” as an order to buy or sell a quantity of an NMS stock having a market value of at least $200,000, provided that such order is not for the account of a broker-dealer. 37 As proposed, Rule 606(b)(3) would apply only to such “institutional orders.” 36 See proposed Rule 600(b)(31). 37 See id. The proposed definition of institutional order applied only to orders for NMS stocks and, therefore, did not include orders in NMS securities that are options contracts. The Commission's proposed definition of “institutional order” dovetailed with the current definition of “customer order,” 38 such that all orders in NMS stocks routed by broker-dealers for their customers, regardless of order dollar value, would be covered by order routing disclosure rules. 39 The Commission's proposed definition maintained a dollar-value threshold analysis to identify the “institutional orders” for which the Rule 606(b)(3) disclosures would be available and distinguish them from “retail orders” that were too small to meet the dollar-value threshold in the definition and for which other disclosures would be available. 40 38 See supra note 5. 39 See Proposing Release, supra note 1, at 49445. Relatedly, the Commission proposed to rename term “customer order” in Rule 600(b) as “retail order.” See infra Section III.B.1. 40 See id. The Commission preliminarily believed that this would be an effective method of focusing the Rule 606(b)(3) disclosures on orders from institutional customers. See Proposing Release, supra note 1, at 49444-45 for additional detail on the Proposal. The Commission solicited comment on alternatives to a dollar-value threshold approach. For example, the Commission asked commenters among other things: (1) Whether dollar value is the proper criterion for defining an institutional order, and (2) whether there are other order characteristics the Commission should consider to distinguish between retail and institutional orders, in addition to, or instead of, a dollar-value threshold. 41 41 See id. at 49445. The Commission also asked whether commenters believe a de minimis exemption from customer-specific reporting under proposed Rule 606(b)(3) is appropriate. Specifically, the Commission asked if commenters believe that the rule should include a de minimis exemption for broker-dealers that receive, in the aggregate, less than a certain threshold number or dollar value of institutional orders. 42 The Commission also asked if the rule should be applicable, with respect to disclosures to any particular customer, only if a broker-dealer receives greater than a certain threshold number or dollar value of institutional orders from that customer. 43 42 See id. at 49449. 43 See id. The Commission received comments on the proposed dollar-value threshold as well as comments in response to its questions regarding a potential de minimis exemption from Rule 606(b)(3) and, after further consideration, is modifying its approach. b. Final Rule and Response to Comments i. Comments Regarding Dollar-Value Threshold The Commission received significant comment on the proposed definition of “institutional order” that criticized the proposed $200,000 threshold as an ineffective proxy for institutional trading interest. 44 Many commenters expressed concern that defining institutional order using the proposed $200,000 threshold would be both over-inclusive by including orders from retail investors with a market value over $200,000 and under-inclusive by excluding orders from institutional customers with a market value less than $200,000, and result in the misclassification of a large number of orders. 45 Two commenters stated that they receive retail investor orders that exceed $200,000 in market value. 46 44 See, e.g., Letter from Theodore R. Lazo, Managing Director and Associate General Counsel, The Securities Industry and Financial Markets Association, dated October 17, 2016 (“SIFMA Letter”) at 2-3; Letter from Mary Lou Von Kaenel, Managing Director, Financial Information Forum, dated September 26, 2016 (“FIF Letter”) at 2-3; Letter from Mary Lou Von Kaenel, Managing Director, Financial Information Forum, dated November 7, 2016 (“FIF Addendum”) at 2; Letter from David W. Blass, General Counsel, Investment Company Institute, dated September 26, 2016 (“ICI Letter”) at 3-7; Letter from John Russell, Chairman of the Board, and James Toes, President and Chief Executive Officer, Security Traders Association, dated September 26, 2016 (“STA Letter”) at 4; HMA Letter at 5-6; Letter from Tyler Gellasch, Executive Director, and Chris Nagy, Director, Healthy Markets Association dated January 6, 2017 (“HMA Letter II”) at 2; CFA Letter at 6-7; Letter from Dennis M. Kelleher, President and Chief Executive Officer, Stephen W. Hall, Legal Director and Securities Specialist, and Lev Bagramian, Senior Securities Policy Advisor, Better Markets, Inc., dated September 26, 2016 (“Better Markets Letter”) at 5; MFA Letter at 3. 45 See, e.g., Letter from Robert J. McCarthy, Director of Regulatory Policy, Wells Fargo Advisors, LLC, dated September 26, 2016 (“Wells Fargo Letter”); Letter from David M. Weisberger, Managing Director, IHS Markit, dated September 26, 2016 (“Markit Letter”); Letter from Jeff Brown, Senior Vice President, Legislative and Regulatory Affairs, Charles Schwab & Co. Inc., dated September 26, 2016 (“Schwab Letter”). 46 See Schwab Letter at 3; Letter from Marc R. Bryant, Senior Vice President and Deputy General Counsel, Fidelity Investments, dated September 26, 2016 (“Fidelity Letter”) at 2-3. Several commenters stated that, for reasons such as obtaining a better price, achieving faster execution, avoiding potential information leakage, avoiding market effect, or the advancement in the sophistication of institutional trading systems, many institutional customers, before submitting their order flow to their broker-dealers, internally divide their order flow into smaller “child” orders that may not meet the proposed $200,000 dollar-value threshold. 47 Multiple commenters offered their own analyses of internal and external data indicating that a large percentage of orders from institutional customers would fall below the $200,000 threshold. 48 One of these commenters stated that the proposed definition of institutional order could exclude disproportionately more orders of smaller funds, orders in less liquid stocks that fall below the $200,000 threshold, and larger orders that are broken up into smaller child orders by institutional customers. 49 47 See Markit Letter at 6-7; Letter from Greg Babyak, Head, Global Regulatory and Policy Group, Bloomberg LP, and Gary Stone, Market Structure Strategy, Bloomberg Tradebook and Bloomberg LP, dated September 26, 2016 (“Bloomberg Letter”) at 11; Letter from Erin K. Preston, Chief Compliance Officer and Associate General Counsel, Dash Financial LLC, dated September 26, 2016 (“Dash Letter”) at 3; Letter from Richard Foster, Senior Vice President and Senior Counsel for Regulatory and Legal Affairs, Financial Services Roundtable, dated September 26, 2016 (“FSR Letter”) at 3-4; MFA Letter at 3; FIF Letter at 3; FIF Addendum at 2; Letter from Nathaniel N. Evarts, State Street Global Advisors, dated September 26, 2016 (“SSGA Letter”) at 1. 48 See Markit Letter at 6-7; Letter from Matt D. Lyons, Global Trading Manager, The Capital Group of Companies, Timothy J. Stark, Market and Transactional Research, The Capital Group of Companies, and Michael J. Triessl, Senior Vice President and Senior Counsel, Capital Research and Management Company, dated September 30, 2016 (“Capital Group Letter”) at 2; Bloomberg Letter at 11-12. 49 See Letter from Adam C. Cooper, Senior Managing Director and Chief Legal Officer, Citadel Securities, dated October 13, 2016 (“Citadel Letter”) at 2. One commenter expressed concern that the dollar-value threshold would exclude the majority of orders from institutions from the enhanced institutional order handling disclosure requirements, diminishing the value of the disclosure and forcing institutional investors to continue individual negotiations to obtain order handling information. 50 Another commenter stated that excluding an unknown portion of a large institution's orders (and perhaps all of a smaller institution's orders) from heightened scrutiny may create opportunities for abuse and evasion, and that investors may therefore seek to deliberately avoid identifying their orders as institutional orders. 51 Another commenter stated that different securities trade differently based on available liquidity and their capacity to move the market. 52 The commenter stated that the proposed definition may force customers to choose between placing orders above the threshold to receive disclosures but at the risk of higher market impact costs or staying below the threshold to protect order information but sacrificing their right to disclosures. 53 50 See ICI Letter at 3. 51 See HMA Letter at 6. 52 See CFA Letter at 7. 53 See id. As illustrated by these comments, there was broad opposition to the $200,000 dollar-value threshold in the proposed definition of institutional order. The Commission is not adopting the proposed definition. Rather than attempt to capture within a definition of “institutional order” the orders that account for most institutional order dollar volume, the comments indicate that market participants would prefer a different approach to order handling disclosures. 54 In light of these comments, the Commission believes that a modified approach to delineating the orders covered by new Rule 606(b)(3) would be more consistent with the expectations of market participants. 54 See, e.g., ICI Letter at 3, 6-7 (noting that adopting a definition of institutional order that would apply to all orders, regardless of size, that an institutional customer submits to its broker-dealer would best enable the Commission to accomplish the objective of providing information necessary for institutional investors to understand broker-dealers' order routing decisions); Letter from Amy B.R. Lancellotta, Managing Director, Independent Directors Council, dated September 26, 2016 (“IDC Letter”) at 2 (supporting ICI's recommendation); Capital Group Letter at 2-3; HMA Letter II (agreeing with Capital Group, and noting that covering all institutional orders is one of the most important aspects of the rule). ii. Commenter Recommendations Regarding a Modified Approach Many commenters urged the Commission to replace the proposed dollar-value threshold with a different approach for identifying the orders covered by the new customer-specific order routing disclosures. 55 They generally supported two different approaches: A number of commenters suggested that the applicability of the new order routing disclosures be based on order type (“held” versus “not held” orders); 56 and a number of other commenters suggested that their applicability be based on the characteristics ( e.g., type or regulatory status) of the entity placing the order. 57 55 See, e.g., MFA Letter at 3-4; CFA Letter at 6-8; FIF Letter at 2-3, 14-15; ICI Letter at 3, 6-7; STA Letter at 3-4; SIFMA Letter at 1-3; FIF Addendum at 2; Healthy Markets Letter at 2; Jon Schneider, Chairman of the Board, and James Toes, President and Chief Executive Officer, Security Traders Association, dated April 11, 2017 (“STA Letter II”) at 2. 56 See, e.g., SIFMA Letter at 3; Bloomberg Letter at 12; Citadel Letter at 2-3; FIF Letter at 2-3, 14-15; FIF Addendum at 2; STA Letter II at 2. See also EMSAC Rule 606 Recommendations, supra note 16. 57 See SSGA Letter at 1; ICI Letter at 3, 6-7; IDC Letter at 2; MFA Letter at 3; Fidelity Letter at 3; CFA Letter at 8; Better Markets Letter at 5. Commenters who supported an order type-based approach suggested that the not held order type classification would be an effective proxy for identifying orders typical of institutional investors for which the existing customer-specific disclosures are inapplicable or inadequate because institutional investor orders are generally not held to the market. 58 Commenters attributed this to the fact that a broker-dealer has time and price discretion in executing a not held order, and institutional investors in particular rely on such discretion for reasons such as minimizing price impact, whereas a broker-dealer must attempt to execute a held order immediately, which typically better suits retail investors who seek immediate executions and rely less on broker-dealer order handling discretion. 59 As one commenter put it, the Rule 606(b) disclosure requirements should be based on whether the broker-dealer has discretion when handling the client's order and, as a general matter, broker-dealers have no discretion in handling retail investor held orders but do have discretion in handling institutional investor not held orders. 60 One commenter also stated that the held/not held approach would provide a targeted, deterministic solution to the issues presented by the proposed order dollar-value-based distinction between retail and institutional orders, and would alleviate the need to identify certain orders as institutional and others as retail for purposes of order routing disclosure. 61 58 See Ameritrade Letter at 2; Letter from Richie Prager, Senior Managing Director, Head of Trading, Liquidity and Investments Platform, Hubert De Jesus, Managing Director, Co-Head of Market Structure and Electronic Trading, Supurna VedBrat, Managing Director, Co-Head of Market Structure and Electronic Trading, and Joanne Medero, Managing Director, Government Relations and Public Policy, BlackRock, Inc., dated September 26, 2016 (“BlackRock Letter”) at 2; Citadel Letter at 2-3; Markit Letter at 4; Schwab Letter at 3; Capital Group Letter at 2-3; KCG Letter at 4; FIF Letter at 2-3; FIF Addendum at 2; STA Letter II at 2. One commenter noted its belief that the vast majority of orders entered by institutional customers are with not-held instructions and the vast majority of orders entered by retail investors are with held instructions. See STA Letter at 4. 59 See Wells Fargo Letter at 5; Markit Letter at 3 n.7; Capital Group Letter at 3; Schwab Letter at 3; Ameritrade Letter at 2 n.2; KCG Letter at 4; FIF Addendum at 2. 60 See SIFMA Letter at 3; see also Capital Group Letter at 2; KCG Letter at 4. 61 See FIF Letter at 2-3, 14-15. Several commenters also stated that basing the Rule 606(b) disclosure requirements on whether an order is held or not held would be straightforward and minimally burdensome because: Broker-dealers and other market participants are very familiar with these order type classifications; classifying orders as held or not held would be consistent with current industry practice; and the terms held and not held are common terms of usage in the securities markets. 62 One of these commenters stated that broker-dealers already must mark orders that they execute as held or not held, 63 and another commenter stated that the held/not held order classifications are commonly recognized in the FIX Protocol. 64 Two commenters pointed out that the held and not held order classifications are already utilized in the Commission's definition of “covered order” in Rule 600(b)(15). 65 One of these commenters stated that not held orders are generally distinguished from held orders in regulations and firms' monitoring processes, and specifically noted that broker-dealers already characterize orders on a held or not held basis to comply with Rule 605's covered order requirement, OATS technical specifications, and other rules such as FINRA Rule 5320. 66 62 See Citadel Letter at 3; Markit Letter at 3, 7-8; KCG Letter at 4; Capital Group Letter at 2-3; SIFMA Letter at 3. 63 See Capital Group Letter at 3. 64 See Citadel Letter at 3. 65 See SIFMA Letter at 3 and n. 4; Market Letter at 3 and n. 8. 66 See Markit Letter at 3-4, 7. Two commenters objected to the held or not held analysis and stated that the applicability of the new customer-specific disclosures should not be based on order type because the held/not held classification is within the control of the order sender. 67 One commenter stated that the held/not held order type-based distinction is an imprecise proxy for the status of the underlying customer, would not cover all institutional orders, and that the distinction may leave out many smaller investment advisers that currently trade through or have some portion of assets under management through “retail” channels. 68 This commenter also stated that the distinction would allow for potential gaming, and that amidst rising concerns with broker-dealers' conflicts of interests, some institutional investors have increasingly come to use held orders. 69 Another commenter, however, understood that some not held orders may come from retail customers, and that institutional clients may send broker-dealers a small amount of held orders, but nevertheless supported scoping the disclosures by the held and not held order classifications. 70 67 See HMA Letter at 7; Dash Letter at 4. 68 See HMA Letter II at 2-3. 69 See id. 70 See SIFMA Letter at 3; see also Markit Letter at 7-8; Schwab Letter at 3; Letter from Manisha Kimmel, Chief Regulatory Officer, Wealth Management, Thomson Reuters, dated September 26, 2016 (“Thomson Reuters Letter”) at 1; Citadel Letter at 3. Some commenters suggested that the applicability of the customer-specific disclosures should be based on the type of the entity placing the order. 71 One commenter argued that this approach would be preferable to an approach based on order type classification because broker-dealers already must know whether their customers are institutional investors. 72 Another commenter stated that orders should not be classified according to the unique order handling typical of an entity, as that characteristic may change over time, whereas the entity type itself remains constant. 73 71 See, e.g., ICI Letter at 6-7; MFA Letter at 3; Fidelity Letter at 3; STA Letter at 4; CFA Letter at 8. 72 See HMA Letter II at 2. 73 See Better Markets Letter at 5. Most of the commenters that supported an entity-centric approach suggested that the Commission rely on FINRA Rule 4512(c), which defines the term “institutional account” for purposes of that rule, as a source for such an approach. 74 Two commenters also suggested as a source FINRA Rule 2210(a)(4), which defines the term “institutional investor” for purposes of that rule, and also incorporates the definition of “institutional account” from FINRA Rule 4512(c). 75 One commenter stated that, because all broker-dealers that handle customer orders for equity securities are FINRA members, they should be accustomed to using the standards supplied in FINRA's rules. 76 74 See ICI Letter at 6-7 n.19; MFA Letter at 3-4; Fidelity Letter at 3; STA Letter at 4; CFA Letter at 8; Bloomberg Letter at 13; see also FIF Letter at 3. 75 See MFA Letter at 3-4; ICI Letter at 6-7 n.19. 76 See ICI Letter at 6-7 and n.19; see also CFA Letter at 8. Some commenters offered additional considerations or recommendations regarding how an entity-based approach should be crafted. For example, one commenter suggested that the new customer-specific disclosures should apply to any order attributed to any entity that is a “large trader” under Section 13(h) of the Exchange Act. 77 Another commenter stated that institutional and retail investors should be defined according to whether the investor is an entity or individual. 78 77 See SSGA Letter at 1; see also 15 U.S.C. 78m(h). Another commenter expressed concern that a large trader-based definition of institutional order would result in considerable overlap among retail customers that also are large traders under Rule 13h-1. See STA Letter at 4. This is one of several examples of commenters critiquing or supporting the views expressed by other commenters regarding the definition of institutional order. See, e.g., IDC Letter at 2 (supporting ICI Letter's recommendations on how to expand the definition of “institutional” order); STA Letter at 4 (supporting remarks made in FIF Letter); Citadel Letter at 3 (noting support for similar proposal from Blackrock Letter and ICI Letter); Ameritrade Letter at 2 (noting commenter support for defining institutional orders by the type of order submitted); HMA Letter II at 2-3 (noting broad commenter support for not defining institutional orders by dollar size). 78 See Better Markets Letter at 5. In addition to the foregoing commenter recommendations, a few commenters suggested that there should be no distinction between retail and institutional customers for purposes of the new Rule 606(b)(3) order handling reports and that all orders should be covered by the Rule 606(b)(3) reports, 79 or that retail and institutional customers should receive the same disclosures. 80 One commenter stated that the goal with respect to both retail investor and large institutional orders should be best execution. 81 79 See HMA Letter at 5; Dash Letter at 3; HMA Letter II at 1-2; Letter from Abraham Kohen, President, AK Financial Engineering Consultants, LLC, dated September 28, 2016 (“Kohen Letter”). 80 See, e.g., Better Markets Letter at 5-7. 81 See HMA Letter at 5. iii. The Commission's Adopted Approach The Commission is not adopting a definition of “institutional order” or an order dollar value-based approach to delineate the applicability of new Rule 606(b)(3). 82 Generally, the amendments to Rule 606(b) are designed to apply required order handling disclosures to any NMS stock order regardless of its dollar value and to require more detailed disclosures regarding how broker-dealers exercise discretion when handling and routing customers' NMS stock orders in today's electronic markets. These disclosures are designed to provide transparency to customers for whom the existing customer-specific disclosures under Rule 606(b) are inapplicable or have become inadequate. Upon further consideration and in light of the views expressed by commenters, the Commission believes that these goals can best be accomplished if the detailed, customer-specific, order handling disclosures set forth in Rule 606(b)(3) generally apply to orders of any dollar value for NMS stock that customers submit to their broker-dealers on a “not held” basis. Accordingly, under Rule 606(b)(3), a broker-dealer must provide the disclosures set forth therein, upon customer request, to any customer that places, directly or indirectly, one or more orders in NMS stock that are submitted on a not held basis with the broker-dealer, subject to two de minimis exceptions discussed below. 83 82 Relatedly, as discussed below, the Commission is not renaming the term “customer order” as “retail order” in Rule 600(b). See infra Section III.B.1. 83 See infra Section III.A.1.b.iv; see also Rule 606(b)(3). Consistent with what was proposed, Rule 606(b)(3) applies only to orders for NMS stocks and does not include orders in NMS securities that are options contracts. Some commenters supported this approach. See STA Letter II at 2-3; FIF Letter at 12. Other commenters recommended that options be included in the amended order handling disclosures being adopted today. See Dash Letter at 1-2; HMA Letter at 12; Markit Letter at 14. The Commission continues to believe that, as noted in the Proposing Release, due to differences in the current market structure for NMS securities that are options contracts—in particular the lack of an over-the-counter market in listed options—the same market structure complexities that exist for NMS stocks do not exist at this time for NMS securities that are options contracts to a degree that warrants the more detailed order handling disclosures proposed herein. See Proposing Release, supra note 1, at 49444 n.101. We believe that basing the applicability of this requirement on whether orders are held or not held serves the purposes of the disclosures. A broker-dealer must attempt to execute a held order immediately; a not held order instead provides the broker-dealer with price and time discretion in handling the order. As a result, the Rule 606(b)(3) disclosures apply to NMS stock orders for which customers have provided their broker-dealers with price and time order handling discretion, and do not apply to orders that the broker-dealer must attempt to execute immediately. The Commission believes that since the disclosures are designed to provide greater transparency into a broker-dealer's exercise of order handling discretion, they should be provided for orders for which broker-dealers actually exercise such discretion. Focusing the customer-specific report in this way will better enable customers to understand their broker-dealers' order routing decisions and the extent to which those decisions may be affected by conflicts of interest or create information leakage. Customers also will be better able to assess their broker-dealers' skill and effectiveness in handling their orders and achieving satisfactory executions. Importantly, as noted by multiple commenters, broker-dealers and other market participants are familiar with the held and not held order type classifications, classifying orders as held or not held would be consistent with current industry practice, and the terms “held” and “not held” are common terms of usage in the securities markets. 84 Indeed, broker-dealers already utilize the “held” and “not held” order classifications to comply with FINRA OATS technical specifications, 85 and existing Commission rules, such as the definition of “covered order” in Rule 600(b), rely on market participants' ability to distinguish between “held” and “not held” orders. As such, the Commission is not adding definitions of these terms to Rule 600(b). The Commission intends for broker-dealers to rely on their current methods for classifying orders as “held” or “not held” for purposes of complying with Rule 606. By leveraging the established not held order classification, Rule 606(b)(3)'s applicability should be easily understood by market participants and the implementation burdens broker-dealers encounter in order to comply with Rule 606(b)(3) should be lessened to the extent that their order handling and routing systems are already configured for not held order classifications. 84 See Citadel Letter at 3; Markit Letter at 3, 7-8; KCG Letter at 4; Capital Group Letter at 2-3; SIFMA Letter at 3. 85 See FINRA OATS Reporting Technical Specifications, September 12, 2016, at pp. 4-2 to 4-3, available at http://www.finra.org/sites/default/files/TechSpec_9122016.pdf . Further, under the Commission's adopted approach, any customer is entitled to receive the Rule 606(b)(3) disclosures for their not held NMS stock orders, subject to two de minimis exceptions. The Commission is not adopting definitions of “institutional order” or “retail order,” and the adopted amendments make no such distinction, based on dollar value of the order or otherwise. In this regard, the Commission's adopted approach is consistent with comments that stated that no such distinction is necessary. Under final Rule 606(b)(3), customers may request the disclosures for any not held NMS stock orders that they submit (subject to the de minimis exceptions, discussed below), including not held NMS stock orders for less than $200,000 in market value, which would have been defined as “retail orders” and not subject to the Rule 606(b)(3) disclosures under the Proposal. The Commission believes it is appropriate to make the Rule 606(b)(3) disclosures available for all not held NMS stock orders (subject to the de minimis exceptions) so customers have information sufficient to evaluate the broker-dealers that are exercising order handling and routing discretion. The Commission believes that it is appropriate for broker-dealers to provide the Rule 606(b)(3) disclosures to those customers for whom the existing customer-specific order routing disclosures in Rule 606(b) are inapplicable or inadequate. Specifically, the Rule 606(b)(3) disclosures are particularly suited to customers that submit not held NMS stock orders because the disclosures set forth detailed order handling information that is useful in evaluating how broker-dealers exercise the discretion attendant to not held orders and, in the process, carry out their best execution obligations and manage the potential for information leakage and conflicts of interest. Moreover, many of the commenters that criticized the Commission's proposed definition of institutional order suggested that all or nearly all of an institutional customer's orders should be covered by the Rule 606(b)(3) disclosures regardless of order dollar value. Some of these commenters supported accomplishing this via an entity-based approach to Rule 606(b)(3)'s applicability, 86 which the Commission has not chosen to adopt for reasons set forth below, and some of these commenters supported the adopted approach. 87 By using the not held order distinction rather than the proposed $200,000 threshold, Rule 606(b)(3) as adopted will cover more order flow than would have been covered under the Proposal. 88 In addition, by using the not held order distinction, Rule 606(b)(3) as adopted will likely result in more Rule 606(b)(3) disclosures for order flow that is typically characteristic of institutional customers—not retail customers—and will likely cover all or nearly all of the institutional order flow. 86 See supra note 58. 87 See supra note 56. 88 See infra Section V.C.1.a.i.3. While some commenters suggested that the new customer-specific disclosures in Rule 606(b)(3) should be available to all orders without any limitation based on entity type or order classification or otherwise, the Commission believes that it is appropriate to differentiate between not held orders and held orders for purposes of order handling information disclosure because broker-dealers generally handle not held orders differently from held orders due to the discretion they are afforded with not held orders but not with held orders. 89 As a result, the information pertinent to understanding broker-dealers' order handling practices for not held orders is not the same as for held orders. 89 See, e.g., Schwab Letter at 3. Indeed, in recent years, routing and execution practices for not held orders have become more automated, dispersed, and complex. 90 In today's electronic markets, broker-dealers' commonly handle such orders by using sophisticated institutional order execution algorithms and smart order routing systems that decide the timing, pricing, and quantity of orders routed to a number of various trading centers, and that may divide a large “parent” order into many smaller “child” orders, and route the child orders over time to different trading centers in accordance with a particular strategy. 91 The order handling disclosures required by Rule 606(b)(3) are designed to take this into account and provide relevant disclosures that, in the Commission's view, will enable customers to better assess their broker-dealers' order execution quality and order handling ability overall and methods for complying with best execution obligations, as well as, more specifically, the degree to which their broker-dealers' order routing practices may involve information leakage or the potential for conflicts of interest. 90 See supra Section I; see also Proposing Release, supra note 1, at 49436. 91 See id. By contrast, the Commission's concern regarding how broker-dealers handle held orders is less about the difficulties posed by more automated, dispersed and complex order routing and execution practices. Rather, the Commission believes that enhanced disclosures for held orders should provide customers with more detailed information including with respect to the financial inducements that trading centers may provide to broker-dealers to attract immediately executable trading interest, as opposed to the different information geared towards not held NMS stock orders that is set forth in Rule 606(b)(3). As noted above and discussed below, the quarterly public disclosures required under Rule 606(a) are indeed being enhanced to provide more detail regarding financial inducements to broker-dealers, and the Commission believes that these disclosures are more appropriately tailored to the characteristics of held order flow and the needs of customers that use held orders. 92 92 As noted supra and infra, the Commission is also is amending Rule 606(a) such that it applies to held orders of any size in NMS stock. Also, the Commission does not disagree with one commenter's statement that best execution should be the goal for orders from both institutional customers and retail investors, and that both types of investors deserve to know how their orders are routed and executed. 93 Best execution is the broker-dealer's legal obligation for all orders, whether from retail or institutional customers. 94 While meeting their best execution obligations, broker-dealers frequently may choose to handle orders in a variety of different ways and choose among a host of available order routing destinations. Because the choices broker-dealers make in this regard are informed by the type of order at hand, for the reasons stated above, the Commission believes that separate disclosures for not held orders and held orders are the better way to help customers understand how their broker-dealers are handling and routing their orders and how well their broker-dealers are performing these functions. While this commenter also stated that the Proposal's reforms for retail customers are inadequate, for the reasons stated above, as well as in Section III.B infra, the Commission disagrees. 93 See HMA Letter at 5. 94 See Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496, 37538 (June 29, 2005) (“Regulation NMS Adopting Release”). FINRA has codified a duty of best execution into its rules. See FINRA Rule 5310. As noted above, other commenters suggested basing Rule 606(b)(3)'s applicability on the characteristics of the customer that submits the order to the broker-dealer. This entity-centric approach suggested by commenters would require the Commission to set forth the types of customers that may request the Rule 606(b)(3) disclosures for their NMS stock orders, but would not entail any differentiation in the types of orders covered by Rule 606(b)(3). As a result, NMS stock orders from qualifying customers that are submitted on a held basis would be covered by the Rule 606(b)(3) disclosures. This is a sub-optimal outcome. Broker-dealers must attempt to execute held orders immediately and are afforded no discretion in handling them; therefore, applying the Rule 606(b)(3) disclosures to held orders would not provide insight into how a broker-dealer exercises order handling and routing discretion. Moreover, including a customer's held orders in the Rule 606(b)(3) report could obfuscate the reports' depiction of the discretion actually exercised by the broker-dealer with respect to not held orders and undermine the very purpose of these disclosures. An entity-based approach also would require the Commission to prescribe institutional status criteria that customers must fit in order to be entitled to receive the disclosures. A risk with such an approach is that the criteria could be over-inclusive or under-inclusive. The Commission is particularly concerned about potential under-inclusiveness because customers that do not fit the criteria would not be entitled to receive the disclosures. To mitigate this risk, the Commission, as suggested by commenters, could leverage certain existing rules that already set forth institutional status criteria. For example, several commenters suggested as sources the definitions of “institutional account” and “institutional investor” in FINRA Rules 2210(a)(4) and 4512(c), respectively. 95 But these definitions serve a purpose for the noted FINRA rules that is different from the purpose similar prescribed criteria would serve for the purpose of Rule 606(b)(3). Under FINRA Rule 4512, a broker-dealer is not required to obtain for “institutional accounts” certain additional information that it is required to obtain for accounts that are not “institutional accounts.” 96 Likewise, under FINRA Rule 2210(a)(4), a broker-dealer is subject to less prescriptive review requirements for “institutional communications” that are solely to “institutional investors” than it is subject to for other, “retail communications.” 97 Under both of these FINRA rules, exclusion from the defined “institutional” criteria triggers a more stringent due diligence or review obligation for the broker-dealer. The opposite would be true under an entity-centric approach to Rule 606(b)—if the institutional status criteria adopted by the Commission were not met, the market participant would be excluded from the more detailed disclosure regime. 98 95 See supra notes 74 and 75 and accompanying text. 96 See FINRA Rule 4512(a)(2). 97 See FINRA Rule 2210. 98 One commenter suggested that the “large trader” designation under Section 13(h) of the Exchange Act serve as the source for the Commission's institutional status criteria ( see SSGA Letter at 1, supra note 77). This approach would, however, include held orders from large traders within the required disclosures. Moreover, to qualify as a large trader under Rule 13h-1, a person must meet daily or monthly aggregate share volume or market value thresholds for transactions in NMS securities. See 17 CFR 242013h-1. Therefore, such an approach would exclude orders from an institutional customer that does not meet the designated thresholds. In addition, because the large trader definition is based on transactions in NMS securities, it takes into account transactions in option contracts that are NMS securities whereas the Commission's amendments to Rule 606(b) apply only to orders for NMS stock. Another commenter stated that institutional and retail investors should be defined according to whether the investor is an entity or individual ( see Better Markets Letter at 5, supra note 78). This approach similarly would include held orders within the Rule 606(b)(3) disclosures. Further, certain natural persons may take on the characteristics of institutions in their trading behavior and utilize not held orders to a significant degree, but they would be categorically excluded from receiving the Rule 606(b)(3) disclosures for such orders under an approach based on an individual versus entity distinction. This categorical exclusion of some customer types from Rule 606(b)(3)'s purview is avoided under the Commission's adopted approach. By basing the application of Rule 606(b)(3) on the held and not held order classifications, no customer is categorically excluded from receiving the Rule 606(b)(3) disclosures. The Commission acknowledges that some commenters stated that an entity-centric approach to Rule 606(b)(3)'s coverage based on the noted FINRA rules would coincide with familiar industry standards regarding the types of market participants that are considered to be “institutional.” 99 But adapting the FINRA rules for the Commission's purposes in Rule 606(b) would present challenges. For example, private funds such as hedge funds may not be covered by the “institutional” definitions in FINRA Rules 2210 or 4512, 100 yet in the Proposing Release the Commission noted, by way of example, that “[a]n institutional customer includes . . . hedge funds,” among others. 101 If the Commission relied solely on the FINRA rules, contrary to the Commission's contemplation in the Proposing Release, hedge funds may not be defined as “institutional” for Rule 606(b) purposes and would not be entitled to the more detailed Rule 606(b)(3) disclosures. Of course, the Commission could modify the criteria used in the FINRA rules to better suit its purposes here, but even then there would still be a risk of under-inclusiveness in the adapted criteria. There also could be new types of market participants that evolve and that trade in an institutional manner, but if they were not covered by the Commission's prescribed institutional status criteria, they would not be entitled to receive the Rule 606(b)(3) disclosures under the rule. 99 See HMA Letter II at 2; CFA Letter at 8; STA Letter at 4. 100 FINRA Rule 4512(c)(3) contains a catch-all provision that includes within the definition of “institutional account” the account of any person with at least $50 million in total assets. An entity that is not otherwise expressly covered by FINRA Rule 4512(c)(1) or (2), such as a hedge fund for example, is not covered by the definition if it has total assets of less than $50 million. As such, if the Commission were to rely on the FINRA rules as suggested by some commenters, smaller entities with less than $50 million in total assets may be excluded from Rule 606(b)(3) even though they may have less bargaining power than their larger competitors and therefore may benefit most from required, standardized order routing disclosures. There also could be disparate results—for example, a registered investment company with less than $50 million in assets would be covered because it is expressly identified in the rule, while a hedge fund with less than $50 million in assets would not be covered. 101 See Proposing Release, supra note 1, at 49433, n.1. Moreover, as noted above, commenters also highlighted the industry familiarity with the not held order classification. 102 And, unlike the “institutional” definitions in the referenced FINRA rules, which apply in contexts completely different from broker-dealer order handling, the not held order classification is already used by broker-dealers specifically for order handling purposes, among other things. For example, FINRA Rule 7440 requires broker-dealers to record certain information, including any “special handling requests,” when an order is received, originated, or transmitted. 103 FINRA's OATS Reporting Technical Specifications state that, when a FINRA member originates or receives an order and then subsequently transmits that order to another desk or department within the firm, the member is required to record and report to OATS, among other things, “special handling instructions that are communicated by the receiving department to a desk or other department, such as `Not Held.' ” 104 102 See Citadel Letter at 3; Markit Letter at 3, 7-8; KCG Letter at 4; Capital Group Letter at 2-3; SIFMA Letter at 3. 103 See FINRA Rule 7440(b)(15) and (c)(1)(G). 104 See FINRA OATS Reporting Technical Specifications, September 12, 2016, at pp. 4-2 to 4-3, available at http://www.finra.org/sites/default/files/TechSpec_9122016.pdf . Basing the applicability of Rule 606(b)(3) on customers' not held NMS stock orders is, in the Commission's view, the most tailored approach to aligning the orders covered by Rule 606(b)(3) with the Commission's intent for the rule to provide more detailed disclosure and enhanced transparency regarding how broker-dealers handle NMS stock orders, and to provide such transparency to customers for whose NMS stock orders the current disclosure regime is inapplicable or inadequate. This approach also is likely to avoid the problems inherent in an entity-centric approach. Further, many commenters, as well as EMSAC, supported basing Rule 606(b)(3)'s application on the not held order classification. Accordingly, under Rule 606(b)(3), a broker-dealer must provide the disclosures set forth therein, upon customer request, to any customer that places, directly or indirectly, one or more orders in NMS stock that are submitted on a not held basis with the broker-dealer, subject to the de minimis exceptions discussed below. iv. De Minimis Exceptions The Commission is adopting in new Rules 606(b)(4) and (b)(5) two de minimis exceptions from Rule 606(b)(3)'s requirements, either of which excepts a broker-dealer from the Rule 606(b)(3) requirements. One of the exceptions focuses on the broker-dealer firm and the other focuses on the individual customer. Specifically, a broker-dealer is not obligated to provide the Rule 606(b)(3) report: (i) To any customer if not held NMS stock orders constitute less than 5% of the total shares of NMS stock orders that the broker-dealer receives from its customers over the prior six months, 105 or (ii) to a particular customer if that customer trades through the broker-dealer, on average each month for the prior six months, less than $1,000,000 of notional value of not held orders in NMS stock. 106 These de minimis exceptions are designed such that the Rule 606(b)(3) requirements apply when a broker-dealer's order flow consists primarily of not held orders for NMS stock and when a customer's trading profile is such that it relies heavily on the discretion of the broker-dealer and so would sufficiently benefit from the Rule 606(b)(3) disclosures. 105 See Rule 606(b)(4). Under the rule, the first time a broker-dealer meets or exceeds the 5% threshold, it has a grace period of up to three calendar months to provide the Rule 606(b)(3) report. There is no such grace period for compliance after the first time the threshold is met or exceeded. See id. 106 See Rule 606(b)(5). As discussed below, however, when either de minimis exception applies, the broker-dealer still must provide, if requested, the Rule 606(b)(1) customer-specific disclosures for not held NMS stock orders that it receives from customers. See infra Section III.A.1.b.vi. The Commission received several comments in response to its questions regarding a potential de minimis exception from customer-specific reporting under proposed Rule 606(b)(3). Multiple commenters supported an exception from Rule 606(b)(3) reporting for broker-dealers that have either a de minimis level of institutional customers or a de minimis amount of institutional trading activity as measured by executed shares as a percentage of all executed shares. 107 These commenters also supported disclosure based on whether an order is held or not held and generally discussed the reasoning for a de minimis exception in that context. 108 Commenters also suggested that firms that receive less than 5% of orders from institutions should be exempt from requirements to provide disclosures for institutional orders, both at the individual investor level and in the aggregate. 109 One commenter stated that the de minimis threshold should be set at 5% of not held orders received. 110 Two commenters noted that there currently is a 5% threshold in Rule 606(a) in connection with the rule's requirement that broker-dealers disclose the identity of any venue to which 5% or more of non-directed orders were routed for execution. 111 One of these commenters stated that the purpose of a de minimis exception is to provide relief so that reporting obligations for a given entity more closely match its actual core business and targeted customer profile. 112 107 See, e.g., FIF Letter at 5, 10; STA Letter at 6; Citadel Letter at 3. 108 See, e.g., FIF Letter at 5, 10; STA Letter II at 2; Citadel Letter at 3; Thomson Reuters Letter at 1; Ameritrade Letter at 2. 109 See STA Letter II at 2; Ameritrade Letter at 2; Wells Fargo Letter at 5. See also Letter from Jeff Brown, Senior Vice President, Legislative and Regulatory Affairs, Charles Schwab & Co. Inc., dated October 30, 2018 (“Schwab Letter II”). 110 See Schwab Letter II at 2. 111 See Ameritrade Letter at 2; Wells Fargo Letter at 5. 112 See Wells Fargo Letter at 5. See also Letter from Stephen John Berger, Managing Director, Government and Regulatory Policy, Citadel Securities, dated October 23, 2018 (“Citadel Letter II”) at 1-2 (noting that the 5% threshold suggested by other commenters should ensure that smaller broker dealers are not adversely affected by the new disclosure requirement, and noting that a threshold based on a percentage of orders or shares received could potentially be set lower than a threshold based on a percentage of executed shares). Some commenters stated that the costs incurred by retail broker-dealers to create systems to generate the Rule 606(b)(3) reports would exceed any benefits. 113 One of these commenters stated that the Rule 606(b)(3) statistics are not relevant to retail-oriented brokers' customer base and would provide them no added benefit, and that requiring retail broker-dealers to generate the statistics would be an onerous task with significant added expense. 114 Two commenters recommended an exemption from Rule 606(b)(3) reporting for firms with a de minimis amount of not held order flow in light of the fact that retail customers occasionally submit not held orders. 115 One commenter believed that, if broker-dealers with a de minimis amount of not held orders are exempted, the majority of the exemptions would be for retail brokers. 116 113 See Ameritrade Letter at 2; Citadel Letter at 3; FIF Letter at 5, 10. 114 See FIF Letter at 5. See also Markit Letter at 17. 115 See Thomson Reuters Letter at 1; Schwab Letter at 3. 116 See STA Letter at 8-9. Other commenters did not support a de minimis exception even if a broker-dealer has limited institutional customer order flow, so that institutional customers can compare order routing among all broker-dealers. 117 One commenter stated that, if a small broker-dealer is able to effectively manage orders from institutional customers in the current complex market environment, it should be able to provide customers with information on their order routing practices. 118 117 See, e.g., Bloomberg Letter at 15; MFA Letter at 4-5. See also Markit Letter at 28. 118 See Capital Group Letter at 4. The Commission believes that a de minimis exception from Rule 606(b)(3) reporting, as set forth in Rule 606(b)(4), presents advantages for certain broker-dealers. Broker-dealers handle different types of order flow, and not all broker-dealers handle a significant amount of not held NMS stock order flow. Indeed, some broker-dealers focus mainly on servicing customers that use held orders in NMS stock, and as such, typically do not handle not held order flow in NMS stock. The Commission believes that it is appropriate to relieve broker-dealers with minimal or zero not held order flow from the obligation to incur the costs associated with having the capability to provide the new Rule 606(b)(3) disclosures for not held NMS stock orders. The Commission does not believe that it would be appropriate to require every broker-dealer, regardless of its customer base and core business, to be compelled to incur the costs required to create the systems and processes necessary to generate the Rule 606(b)(3) reports. The Commission does not intend to introduce a wholesale change in order handling and routing disclosure requirements such that broker-dealers whose order flow consists almost entirely of held orders must also become prepared to provide disclosures that focus on trading activity characteristics of not held orders. In the Commission's view, the potential benefits of the Rule 606(b)(3) disclosures for customers of such broker-dealers do not justify the costs to such broker-dealers of developing the necessary systems and mechanisms for providing the disclosures. There would be no expected benefits of Rule 606(b)(3) in circumstances where a broker-dealer does not currently handle any not held NMS stock order flow. Nevertheless, absent a de minimis exception, such a broker-dealer could feel compelled to incur the costs and burdens associated with being able to provide the Rule 606(b)(3) disclosures in order to ensure compliance with the rule should it receive not held orders in the future. The Commission believes that it is appropriate to relieve any such broker-dealers of these potential costs and unnecessary burdens. Likewise, there would be only limited benefits of Rule 606(b)(3) in circumstances where broker-dealers handle a minimal amount of not held orders, and the Commission does not believe that such benefits would justify the costs to broker-dealers in these circumstances. While some commenters opposed a de minimis exemption on grounds that institutional customers should be able to compare orders across all broker-dealers and that broker-dealers capable of handling institutional customer orders should be able to provide the Rule 606(b)(3) information, 119 the Commission believes that these comments rest on an unlikely premise that it is broker-dealers that handle primarily institutional customer orders that would be excepted under Rule 606(b)(4). To the contrary, consistent with other commenters' views, 120 the Commission expects the de minimis exceptions to be relevant mainly in the context of broker-dealers that handle almost entirely held orders from customers but may occasionally handle not held orders from customers. Indeed, commenters noted that a small percentage of retail customers may submit not held orders, whether for purposes of working an order in illiquid securities or for other purposes. In these circumstances, the Commission believes that broker-dealers that focus on servicing such customers should not be required to incur the costs or burdens associated with building the systems and other capabilities necessary to provide the Rule 606(b)(3) disclosures when they are likely to handle not held orders only occasionally and separate from their core business of handling held orders. 121 119 See MFA Letter at 4-5; Capital Group Letter at 4. 120 See, e.g., Ameritrade Letter at 2; Citadel Letter at 3. 121 See Wells Fargo Letter at 5. Accordingly, the firm-level de minimis exception to Rule 606(b)(3), as expressed in Rule 606(b)(4), focuses on the broker-dealer's overall order flow across all of its customers. The Commission believes that the scope of this exception will appropriately cover most broker-dealers that handle almost entirely held order flow. A broker-dealer that handles not held NMS stock order flow that is less than 5% of the total shares of NMS stock orders in a six calendar month period that it receives from its customers most likely does not make, as a matter of course, the routing decisions for which Rule 606(b)(3) is designed to provide enhanced transparency. 95% or more of such a broker-dealer's NMS stock order flow would be held orders. The Commission does not believe that it is appropriate to require such a broker-dealer to expend the effort and incur the expense necessary to be able to provide disclosures that are primarily aimed at order handling that is rarely, if ever, employed by the broker-dealer. The Commission is adopting a firm-level de minimis exception that is based on the “percentage of shares of not held orders in NMS stocks the broker or dealer received from its customers” (emphasis added) rather than the percentage of not held orders in NMS stocks or other measures suggested by commenters. 122 The purpose of the firm-level de minimis exception is to except from the Rule 606(b)(3) disclosure requirements those broker-dealers that receive zero or minimal not held NMS stock order flow from their customers and whose core business does not involve handling or routing such order flow. The Commission believes that the percentage of shares of not held orders is an appropriate measure for the calculation of the firm-level de minimis exception because it more accurately reflects the nature of a broker-dealer's business activities than other suggested approaches. 122 See, e.g., Schwab Letter II at 2. The other methods that commenters suggested for calculating a firm-level de minimis threshold— e.g., based on the percentage of not held orders (not shares) in NMS stocks—are in the Commission's view less accurate indicia of the broker-dealers to whom this aspect of Rule 606 is intended to apply and therefore would result in a less tailored exception. For example, the use of a “per order” threshold for the firm-wide de minimis exception would result in the equal treatment for purposes of a firm's de minimis calculation of, on the one hand, a single order for 10 shares of Corporation X, and on the other hand, a single order for 100,000 shares of Corporation X. The Commission believes that in this example, the two orders should not be afforded equal treatment and that the order for 100,000 shares is more indicative of the broker-dealer's business and thus should be given greater weight than the order for 10 shares. Indeed, in the aforementioned example, the broker-dealer would likely need to apply more discretion when executing the order for 100,000 shares (to minimize potential information leakage and price impact) than for an order for 10 shares. As discussed above, the new Rule 606(b)(3) disclosures are intended to provide customers with detailed information concerning how broker-dealers exercise discretion, particularly for larger orders (including those broken up into several smaller child orders). Thus, if the firm-level de minimis threshold were calculated in a manner that did not account for shares received, there would be greater risk that a broker-dealer exercising discretion in handling larger orders, potentially as a meaningful portion of its business, would not be subject to the new Rule 606(b)(3) disclosure requirement. As noted below, Commission supplemental staff analysis found that among 342 broker-dealers that receive not held orders from customers, about 8% (28 broker-dealers) would receive a de minimis exception from Rule 606(b)(3) requirements pursuant to Rule 606(b)(4). 123 23 of the 28 broker-dealers that would be eligible for the de minimis exception receive not held orders less than 2.5% of the total shares of their orders in the sample and five of the 28 broker-dealers receive not held orders greater or equal to 2.5% and less than 5% of the total shares of their orders in the sample. 124 Thus, the 5% threshold in Rule 606(b)(4) creates a narrow exception from Rule 606(b)(3) among broker-dealers that receive not held orders from customers and would allow for a reasonably small increase in not held order flow as a percentage of total order flow before one of these broker-dealers would be subject to the requirements of Rule 606(b)(3). Those broker-dealers covered by the exception likely handle not held NMS stock order flow only occasionally and separate from their core business, and therefore, in the Commission's view, should not be subject to the requirements of Rule 606(b)(3). In addition, some commenters that supported a firm-level de minimis exception specifically suggested that the threshold be set at the 5% level. 125 Accordingly, the Commission believes that the 5% threshold for the firm-level de minimis exception is reasonable given the goals of the rule. 123 See infra Section V.C.1.a.ii. 124 See id. 125 See supra note 109. A broker-dealer is covered by the firm-level de minimis exception as long as its customer not held NMS stock order flow continues to be less than the 5% firm-level threshold. A broker-dealer is no longer excepted from the purview of Rule 606(b)(3) once and as long as it meets or surpasses the firm-level threshold of the de minimis exception. Specifically, when a broker-dealer has equaled or exceeded the firm-level threshold, it must comply with Rule 606(b)(3) for at least six calendar months (“Compliance Period”) regardless of the volume of not held NMS stock orders the broker-dealer receives from its customers during the Compliance Period. 126 Therefore, during the Compliance Period, the broker-dealer must provide the Rule 606(b)(3) report to a customer for any of the customer's not held NMS stock orders submitted to the broker-dealer during the Compliance Period (subject to the customer-level de minimis exception set forth in Rule 606(b)(5)). The Compliance Period begins the first calendar day of the next calendar month immediately following the end of the six calendar month period for which the broker-dealer equaled or exceeded the firm-level threshold, unless it is the first time the broker-dealer has equaled or exceeded the threshold. 127 The first time a broker-dealer equals or exceeds the firm-level threshold, there is a grace period of three calendar months before the Compliance Period begins and the broker-dealer must comply with Rule 606(b)(3) requirements. 128 The customer is not entitled to receive Rule 606(b)(3) reports for orders handled during the grace period, as the grace period is not part of the Compliance Period. After the three calendar month grace period, beginning the first calendar day of the fourth calendar month after the end of the six calendar month period for which the broker-dealer equaled or exceeded the firm-level threshold, the broker-dealer must provide the Rule 606(b)(3) report prospectively for not held NMS stock orders submitted by customers from that date through the next six calendar months. 126 See Rule 606(b)(4). 127 See id. 128 See id. The Commission believes that the limited three-month grace period is appropriate because it will allow a firm time to come into compliance with the Rule 606(b)(3) requirements when its not held NMS stock order flow crosses the Rule 606(b)(4) firm-level de minimis threshold for the first time. The grace period affords a broker-dealer time to develop the systems and processes and organize the resources necessary to generate the Rule 606(b)(3) reports. At the same time, should such a broker-dealer subsequently fall below the de minimis threshold, the Commission believes that no such grace period for Rule 606(b)(3) is necessary if and when that broker-dealer's not held NMS stock order flow again meets or crosses the firm-level de minimis threshold such that the broker-dealer is again subject to the Rule 606(b)(3) requirements. The broker-dealer should already have developed the necessary systems and processes for providing the Rule 606(b)(3) report in connection with its subjection to Rule 606(b)(3). 129 129 A broker-dealer whose not held NMS stock order flow from its customers equals or exceeds the five percent threshold must be able to provide the Rule 606(b)(3) reports to its customers beginning on the compliance date for these rule amendments. As such, broker-dealers will need to determine whether their customer not held NMS stock order flow equaled or exceeded the 5% threshold for the six calendar month period that ends in the calendar month that includes the effective date of these rule amendments. Since the compliance date for these rule amendments is 180 days after publication in the Federal Register , and since the effective date is 60 days after Federal Register publication, broker-dealers that equaled or exceeded the 5% threshold during the six calendar month period ending in the calendar month that includes the effective date will have nearly four months between the effective date and compliance date to prepare to provide the Rule 606(b)(3) reports. Rule 606(b)(4) requires compliance with Rule 606(b)(3) for “at least” six calendar months for a broker-dealer that equals or exceeds the firm-level de minimis threshold. The Commission believes that it is appropriate to require a minimum Compliance Period of six calendar months in order to coincide with the six-month timeframe of Rule 606(b)(3). Customers of a broker-dealer that is or becomes subject to Rule 606(b)(3) therefore will be able to request a Rule 606(b)(3) report that contains at least one full time period of disclosures contemplated by Rule 606(b)(3). 130 There is no maximum period of time that a broker-dealer may be subject to Rule 606(b)(3)—a broker-dealer that consistently receives not held NMS stock orders from its customers at a rate that equals or exceeds the 5% threshold will be required to comply with Rule 606(b)(3) month after month. Rule 606(b)(4) is designed to require broker-dealer compliance with Rule 606(b)(3) for as long as the broker-dealer's not held NMS stock order flow from its customers equals or exceeds the 5% threshold, subject to the minimum Compliance Period of six calendar months. 130 As noted above, a broker-dealer is not required to provide the Rule 606(b)(3) report for orders received when the broker-dealer was not subject to Rule 606(b)(3). So, for example, a broker-dealer that is subject to Rule 606(b)(3) as of June 1 would be required to provide the Rule 606(b)(3) information for not held NMS stock orders received from a customer on June 1 through at least November 30 of that calendar year (subject to the customer-level de minimis exception and a three-month grace period if first time the firm is required to provide a report pursuant to Rule 606(b)(3)). A customer could request a Rule 606(b)(3) report prior to the end of that period, but the report would only be required to include disclosures as of June 1 (if there is no three-month grace period). Rule 606(b)(4) also is designed to enable a broker-dealer that is subject to Rule 606(b)(3) for six calendar months (or longer) subsequently to avail itself of the firm-level de minimis exception if its not held NMS stock order flow no longer equals or exceeds the 5% threshold. Specifically, under Rule 606(b)(4), if, at any time after the end of the Compliance Period, the broker-dealer's not held NMS stock order flow falls below the 5% threshold for the prior six calendar months, the broker-dealer is not required to comply with Rule 606(b)(3), except with respect to orders received during the Compliance Period. 131 Thus, after the broker-dealer's initial Compliance Period, Rule 606(b)(4) provides for a rolling month-to-month assessment of whether the broker-dealer must continue to comply with Rule 606(b)(3) or may avail itself of the Rule 606(b)(4) de minimis exception. 131 See Rule 606(b)(4). An example is set forth in the paragraph below. For example, suppose a broker-dealer has equaled or exceeded the firm-level threshold and therefore must comply with Rule 606(b)(3) for a six calendar month period that begins on January 1 and ends on June 30 (assuming this Compliance Period started after a three-month grace period, if this was the first time the broker-dealer has had to comply with Rule 606(b)(3)). If, in the beginning of July, the broker-dealer determines that its not held NMS stock order flow equaled or exceeded the threshold for January 1 through June 30, the broker-dealer must continue to comply with Rule 606(b)(3) for July. If, on the other hand, the broker-dealer determines that its not held NMS stock order flow was below the 5% threshold for January 1 through June, the broker-dealer would not be required to comply with Rule 606(b)(3) for July 1 through July 31. In the beginning of August, the broker-dealer would determine if it is subject to Rule 606(b)(3) based on its order flow for the prior six calendar month period, which this time would be the period from February 1 through July 31. If the broker-dealer met the threshold for that six calendar month period, and had also met it for the period January 1 through June 30 such that it was required to comply with Rule 606(b)(3) for July, the broker-dealer would be required to continue complying with Rule 606(b)(3) through August. If the broker-dealer met the threshold for the February 1 through July 31 period but had not met it for the January 1 through June 30 period and was not required to comply with Rule 606(b)(3) for July, the broker-dealer would start a new Compliance Period that would run from August 1 through January 31 of the following calendar year. In this scenario, the broker-dealer would be required to provide Rule 606(b)(3) disclosures for not held NMS stock orders received from a customer during the prior six calendar months, except for any such orders that the broker-dealer received during July when the broker-dealer was not required to provide reports pursuant to Rule 606(b)(3). Table A below contains an example of a broker-dealer firm that meets or exceeds the 5% de minimis threshold for the first time and enters a six-month Compliance Period after a three-month grace period. Table A below also reflects that, after the initial six-month Compliance Period, the broker-dealer's required compliance with Rule 606(b)(3) continues on a rolling month-to-month basis. Table B below contains an example where there is no grace period and a previously compliant broker-dealer firm begins a new Compliance Period after an intervening period of not meeting the 5% threshold. Table A—Firm Equals or Exceeds 5% Threshold for the First Time Event Period examined for qualifying threshold Obligation Firm determines in Jan. 2020 that it equaled/exceeded threshold for first time; grace period begins July 1-Dec. 31, 2019 Prepare to collect and report required data for Compliance Period beginning Apr. 1, 2020. On Apr. 1, 2020, grace period ends and six-month Compliance Period begins Reporting is mandatory during Compliance Period regardless of whether threshold is equaled or exceeded in prior six calendar months Begin collection of required data for orders received during Compliance Period. May 2020 Provide reports for Apr. 1 to Apr. 30, 2020 June 2020 Provide reports for Apr. 1 to May 31, 2020 (continue adding prior month's data to report each successive month of the Compliance Period). Initial Compliance Period ends on Sept. 30, 2020 Provide reports for full Compliance Period, Apr. 1 to Sept. 30, 2020 (Sept. data not required to be provided before 7th business day of Oct.). On Oct. 1, firm determines that it equaled/exceed threshold; Compliance Period extends through Oct. 31, 2020 Apr. 1 to Sept. 30, 2020 Provide reports for May 1 to Oct. 31, 2020. On Nov. 1, firm determines that it equaled/exceed threshold; Compliance Period extends through Nov. 30, 2020 May 1 to Oct. 31, 2020 Provide reports for June 1 to Nov. 30, 2020. Continue assessing, on a rolling basis, whether equal/exceed threshold for prior six month period Prior six calendar months, on a rolling basis Provide reports for prior six month period as long as threshold continues to be met. Table B—Previously Compliant Firm Equals or Exceeds 5% Threshold After Intervening Period of not Meeting Threshold Event Period examined for qualifying threshold Obligation Firm determines in Jan. 2020 that it equaled/exceeded 5% threshold (not for the first time); six-month Compliance Period begins Jan. 1, 2020 July 1 to Dec. 31, 2019 Begin collection of required data for orders received during Compliance Period. Six-month Compliance Period ends on June 30, 2020 Reporting is mandatory during Compliance Period regardless of whether threshold is equaled or exceeded in prior six calendar months Provide reports for full Compliance Period, Jan. 1 to June 30, 2020 (June data not required to be provided before 7th business day of July). Firm determines in July 2020 that it did not equal/exceed threshold; Compliance Period not extended Jan. 1 to June 30, 2020 Firm not required to collect or report data for July 2020 but must continue to provide reports for prior Compliance Period, Jan. 1 to June 30, 2020. Firm determines in Aug. 2020 that it equaled/exceeded threshold; new Compliance Period begins Feb. 1 to July 31, 2020 Begin collection of required data for orders received during new Compliance Period, Aug.-Jan. 31, 2021; provide reports for portion of prior six months that is covered by a Compliance Period, i.e., Feb. 1 to June 30, 2020 (July 2020 not within Compliance Period). Oct. 2020 Reporting is mandatory during Compliance Period regardless of whether threshold is equaled or exceeded in prior six calendar months Provide reports for Apr. 1 to June 30, 2020; Aug. 1 to Sept. 30, 2020. Six-month Compliance Period ends on Jan. 31, 2021 Provide reports for Aug. 1, 2020 to Jan. 31, 2021 (Jan. 2021 data not required to be provided before 7th business day of Feb. 2021). The other de minimis exception to Rule 606(b)(3) focuses on each customer's order flow. 132 Whereas the firm-level de minimis exception is designed to relieve mainly broker-dealers that do not regularly handle not held orders of the Rule 606(b)(3) obligations, the customer-level exception is designed to relieve broker-dealers from the obligation to provide the Rule 606(b)(3) disclosures to particular customers that do not trade NMS stocks in a manner that generally relies on a broker-dealer's use of discretion over order routing and handling. 132 See Rule 606(b)(5). The Commission expects that the benefits of the Rule 606(b)(3) disclosures will accrue mainly for customers that trade regularly with significant levels of not held NMS stock order flow. The new customer-specific order handling disclosures are intended to provide such customers with insight into how their brokers exercise order handling discretion over a period of time. In order to accurately reflect a broker's order handling behavior, the customer-specific disclosures must contain ample order data. The Commission believes that $1,000,000 of notional value traded on average each month for the prior six months is a level of order flow that would allow for meaningful order handling disclosures. A Rule 606(b)(3) report covering a customer's prior six months of trading activity would include at least $6 million worth of the customer's trades. The Commission believes that such a sample of trading activity would be large enough to not be misleadingly colored by one-off or infrequent routing choices by the broker-dealer or order handling requests by the customer. Therefore, such a sample size would provide the customer with an accurate and reliable depiction of how its broker-dealer generally handles its not held NMS stock order flow. The Commission also believes that the customer-level de minimis threshold is set at a sufficiently low level such that the exception captures customers that do not trade regularly or in significant quantity and who would not therefore realize the benefits of the rule. Based on the Commission's experience and understanding of the frequency and quantities in which various market participants tend to trade, the Commission believes that this threshold is a relatively low one for more active traders, including customers that have an interest in evaluating their broker-dealers' order handling services, but high enough such that the exception will capture customers that trade infrequently or in small quantities and for whom the detailed Rule 606(b)(3) report would not be warranted or meaningful. Indeed, customers that trade on average each month for the prior six months less than $1,000,000 of notional value of not held orders through the broker-dealer are not likely to require the more complex order handling tools offered by the broker-dealer that would warrant or make meaningful a detailed review of the broker-dealer's order handling decisions. Even if a customer is sufficiently sophisticated to utilize not held orders and analyze the Rule 606(b)(3) information, unless the customer submits not held orders to a degree that generates a meaningful sample of order handling and routing data, the Rule 606(b)(3) report will not provide a reliable basis for assessing the broker-dealer's activity. In addition, as discussed below, 133 part of the reason why the Rule 606(b)(3) information is provided in the aggregate for all orders sent to each venue, and not on an order-by-order basis, is to protect broker-dealers from potentially disclosing sensitive or proprietary information regarding their order handling techniques. If the rule allowed customers to request the disclosures for discrete not held orders or a de minimis level of not held order flow, there would be heightened risk that customers could gain insight into the broker-dealer's order handling techniques by perhaps reverse engineering how the broker-dealer handled a particular order. A broker-dealer's internal process for determining how to handle and route individual orders—such as, for example, the specific routing destinations chosen and the timing for sending child orders—is typically highly sensitive and proprietary information that broker-dealers guard closely. By requiring the Rule 606(b)(3) disclosures only for non-de minimis levels of not held trading activity, the customer-level de minimis exception helps ensure that the aggregated information provided under Rule 606(b)(3) reflects a robust amount of trading activity from which a customer is unable to glean this sensitive or proprietary information. 133 See infra Section III.A.6. While broker-dealers may, by rule, be excepted from Rule 606(b)(3) due to the firm-level de minimis exception, or excepted from providing the Rule 606(b)(3) disclosures to certain customers due to the customer-level de minimis exception, the Commission notes that some broker-dealers, for business reasons, may choose to provide the new customer-specific order handling disclosures to their customers regardless of the de minimis exceptions and that customers below the customer-level de minimis threshold could move their order flow to such firms. v. Orders for the Account of a Broker-Dealer As noted above, the Commission's proposed definition of institutional order explicitly excluded orders for the account of a broker-dealer, and such orders were not covered by proposed Rule 606(b)(3). Consistent with what was proposed, Rule 606(b)(3), as adopted, does not apply to orders from broker-dealers. Some commenters argued that orders for the account of a broker-dealer should be included in the order handling reports required under Rule 606 and, therefore, such orders should not be excluded from the proposed definition of institutional order in Rule 600(b). 134 The Commission understands these comments to pertain to the proper scope of a broker-dealer's reporting obligations under Rule 606(b)(3), and as such they are discussed in detail in Section III.A.3, infra. As discussed in Section III.A.3, infra, the Commission continues to believe that the scope of a broker-dealer's obligation under Rule 606(b)(3) properly does not extend to orders placed by a broker-dealer. 134 See Markit Letter at 3 n.6, 18; Dash Letter at 1, 4-5; FIF Letter at 2, 8, 16-17; SIFMA Letter at 1, 3. vi. Rule 606(b)(1) To incorporate new Rule 606(b)(3) into the existing regulatory structure, the Commission must make corresponding revisions to Rule 606(b)(1), which is the pre-existing customer-specific order routing disclosure rule. Prior to today, Rule 606(b)(1) did not differentiate between NMS stock orders from customers submitted on a held or not held basis. As a result, absent amendment to Rule 606(b)(1), not held orders in NMS stock that are covered by Rule 606(b)(3) also would be covered by Rule 606(b)(1). This is not the Commission's intent. As discussed above, the Commission is requiring Rule 606(b)(3) disclosures to be available for not held NMS stock orders, subject to two de minimis exceptions. For held NMS stock orders, or for instances when a de minimis exception would except a broker-dealer from providing Rule 606(b)(3) disclosures, the existing disclosure requirements of Rule 606(b)(1) would apply. The Commission is amending Rule 606(b)(1) to require a broker-dealer, upon customer request, to provide the disclosures set forth in Rule 606(b)(1) for orders in NMS stock that are submitted on a held basis, and for orders in NMS stock that are submitted on a not held basis and for which the broker-dealer is not required to provide the customer a report under Rule 606(b)(3). 135 As a result, any NMS stock order from a customer triggers Rule 606(b) order handling disclosure requirements. This is consistent with the Commission's stated intent in the Proposal for all orders in NMS stock routed by broker-dealers for their customers to be encompassed by order routing disclosure rules regardless of order size. 136 135 See Rule 606(b)(1). Rule 606(b)(1) also requires a broker-dealer to provide the disclosures for orders (whether held or not held) in NMS securities that are option contracts. As explained above ( see supra note 83), the Commission is not altering Rule 606(b)'s application to orders for NMS securities that are option contracts, and so the adopted amendments to Rule 606(b)(1) continue the rule's prior application to option contract orders. 136 See Proposing Release, supra note 1, at 49445. Because there is no dollar-value threshold in Rule 606(b) as adopted, there are two categories of NMS stock orders that would have been covered by Rule 606(b)(3) under the Proposal but instead are covered by Rule 606(b)(1) under the adopted approach. First, a customer's held NMS stock order that has a market value of at least $200,000 will be covered by the Rule 606(b)(1) disclosures (and, as discussed below, the Rule 606(a) public disclosures) whereas, under the Proposal, such an order would have been covered by the Rule 606(b)(3) disclosures. 137 As discussed above, 138 because broker-dealers must attempt to execute held NMS stock orders immediately and have no price or time routing discretion with such orders, the Commission does not believe that the Rule 606(b)(3) disclosures are appropriate for such orders, even if they are for $200,000 or more. Indeed, as explained supra and infra, 139 the Commission's concerns with respect to broker-dealer handling of held NMS stock orders relate mainly to financial inducements to attract held order flow from broker-dealers, and those concerns persist regardless of the size of the held order. Held NMS stock orders of any dollar value should therefore be covered by disclosures designed to provide more transparency into such financial inducements and the potential conflicts of interest faced by broker-dealers which, as discussed infra, is what the enhancements to Rule 606(a) in particular are designed to achieve. 140 137 Conversely, a customer's not held order in NMS stock that has a market value less than $200,000 will be covered by the Rule 606(b)(3) disclosures whereas, under the Proposal, such an order would have been covered by the Rule 606(b)(1) disclosures (and the Rule 606(a) public disclosures). The Commission believes this is the proper result for the reasons set forth supra in Section III.A.1.b. 138 See supra Section III.A.1.b.iii. 139 See id.; see also infra Section III.B.1.b. 140 See infra Section III.B.1.b. Second, compared to the Proposal, a not held NMS stock order for at least $200,000 that is from a customer that does not meet the customer-level de minimis threshold or that the customer submits to a broker-dealer that qualifies for the firm-level de minimis exception will be covered by Rule 606(b)(1) whereas, under the Proposal, any not held NMS stock order for at least $200,000 would have been covered by Rule 606(b)(3). The Commission believes that it is the appropriate result for Rule 606(b)(3) not to apply to such an order and for Rule 606(b)(1) to apply instead. As discussed above, 141 the firm-level de minimis exception in Rule 606(b)(4) targets broker-dealers that mainly handle customer held orders but may occasionally handle a not held order from one of their customers. The Commission believes that such a broker-dealer should be entitled to the relief from Rule 606(b)(3) provided by the firm-level de minimis exception if it receives a large not held NMS stock order, including one that is for $200,000 or more, yet still does not receive aggregate not held NMS stock order flow that exceeds the firm-level de minimis threshold. 141 See infra Section III.A.1.b.iv. The Commission believes that, in most cases, a customer that trades in NMS stock order dollar values of $200,000 or more and is sufficiently sophisticated to utilize not held orders, will also be sufficiently sophisticated to submit such orders to broker-dealers that are not excepted from Rule 606(b)(3) by the firm-level de minimis exception, should the customer desire the Rule 606(b)(3) information (and meet or surpass the customer-level de minimis threshold). In addition, as discussed above, the customer-level de minimis exception targets customers whose trading activity is not substantial enough to provide a sample of data that would accurately and reliably reflect a broker-dealer's order handling behavior and make the Rule 606(b)(3) disclosures meaningful. Thus, should a customer that submits a not held NMS stock order for $200,000 or more not meet the customer-level de minimis threshold (a scenario that the Commission believes is unlikely to occur in most cases), the Commission believes that Rule 606(b)(1) is the appropriate recourse for the customer regardless of the dollar value of any of the customer's individual orders. If requested, the Rule 606(b)(1) disclosures provide the customer with information as to the venues to which its orders were routed, whether the orders were directed or non-directed, and the time of any transactions that resulted from the orders. The Commission believes that these disclosures provide information that is more meaningful in light of the overall extent to which the customer trades, and are sufficient to provide a basis for the customer to engage in further discussions with its broker-dealer regarding the broker-dealer's order handling practices. vii. Definitions of “Directed Order” and “Non-Directed Order” The Commission is adopting revised definitions of the terms “directed order” 142 and “non-directed order” 143 under Rule 600(b). These terms are used throughout Rule 606. They are referenced in Rule 606(a) and Rule 606(b)(1) and, as discussed infra, 144 are referenced in new Rule 606(b)(3). Therefore, these terms are being defined compatibly with Rule 606 as amended, which as adopted does not distinguish between NMS stock orders based on order dollar value. 142 A directed order is a customer order that the customer specifically instructed the broker-dealer to route to a particular venue for execution. See 17 CFR 242.600(b)(19). 143 A non-directed order is any customer order other than a directed order. See 17 CFR 242.600(b)(48). 144 See Section III.A.5.b. Specifically, Rule 600(b) prior to these amendments defines the terms directed order and non-directed order in reference to a “customer order,” and the term “customer order” includes a $200,000 dollar value threshold for NMS stock orders that the Commission is not incorporating into Rule 606 as amended. Thus, the Commission is removing the reference to “customer order” from the definitions of “directed order” and “non-directed order” to eliminate the $200,000 dollar-value threshold for NMS stock orders incorporated into those terms. Accordingly, as amended, the term “directed order” means an order from a customer that the customer specifically instructed the broker-dealer to route to a particular venue for execution, and the term “non-directed order” means any order from a customer other than a directed order. 145 By eliminating the term “customer order” and instead referring to “an order from a customer,” these amended definitions do not incorporate the dollar value limitations in the definition of the term “customer order.” 145 See Rules 600(b)(20) and 600(b)(49). Otherwise, however, the amended definitions of “directed order” and “non-directed order” are consistent with the pre-existing definitions. While the amended definitions eliminate the previously existing order dollar value limitation in the cross-referenced term “customer order,” they maintain the pre-existing definitions' exclusion of orders from a broker-dealer. In this regard, the Commission notes that the amended definitions of “directed order” and “non-directed order” continue to incorporate the term “customer,” which is defined in Rule 600(b) as any person that is not a broker-dealer. 146 Thus, the defined terms “directed order” and “non-directed order,” as amended, apply only to orders that are from a person that is not a broker-dealer. 146 See 17 CFR 242.600(b)(16). 2. Definition of Actionable Indication of Interest a. Proposal To further facilitate the updated order handling disclosure regime, the Commission proposed to amend Rule 600 to include a definition of “actionable indication of interest.” 147 Specifically, the Commission proposed that, under proposed Rule 600(b)(1) of Regulation NMS, an actionable IOI be defined as “any indication of interest that explicitly or implicitly conveys all of the following information with respect to any order available at the venue sending the indication of interest: (1) Symbol; (2) side (buy or sell); (3) a price that is equal to or better than the national best bid for buy orders and the national best offer for sell orders; and (4) a size that is at least equal to one round lot.” 148 147 See proposed Rule 600(b)(1). As the Commission indicated in 2009, an actionable IOI is a privately transmitted message by certain trading centers, such as an ATS or an internalizing broker-dealer, to selected market participants to attract immediately executable order flow to such trading centers, and functions in some respects similarly to a displayed order or a quotation. See Securities Exchange Act Release No. 60997 (November 13, 2009), 74 FR 61208, 61210 (November 23, 2009) (“Regulation of Non-Public Trading Interest Proposing Release”). 148 See proposed Rule 600(b)(1). See also Proposing Release, supra note 1, at 49445-49447 for additional detail on the Commission's proposal. As noted in the Proposing Release, this definition is based on and substantively similar to the Commission's description of actionable IOIs in the Regulation of Non-Public Trading Proposing Release in 2009. See Regulation of Non-Public Trading Interest Proposing Release, supra note 147. b. Final Rule and Response to Comments The Commission is adopting as proposed the definition of actionable indication of interest under Rule 600(b)(1) of Regulation NMS. 149 Accordingly, under final Rule 600(b)(1), actionable IOI means any indication of interest that explicitly or implicitly conveys all of the following information with respect to any order available at the venue sending the indication of interest: (1) Symbol; (2) side (buy or sell); (3) a price that is equal to or better than the national best bid for buy orders and the national best offer for sell orders; and (4) a size that is at least equal to one round lot. 149 See Rule 600(b)(1). By defining actionable IOIs in this manner, the Rule 606(b)(3) order handling reporting requirements mandate that a broker-dealer disclose its activity communicating to external liquidity providers for them to send an order to the broker-dealer in response to a not held NMS stock order of a customer of the broker-dealer. The Commission continues to believe that including these disclosures relating to actionable IOI activity in the Rule 606(b)(3) order handling reports would better enable customers to understand and evaluate how broker-dealers handle their orders, in particular with respect to the potential for information leakage stemming from broker-dealers' use of actionable IOIs. The Commission also continues to believe that the definition of actionable IOI is appropriately designed to capture trading interest that is the functional equivalent to an order or quotation. Commenters generally supported the creation of a definition of actionable IOI in Rule 600(b), but some commenters expressed concerns about and suggested revisions to the Commission's proposed definition. 150 One of the main concerns was that it was not sufficiently clear from the Proposal what it means for an IOI to be “actionable.” 151 In this regard, some commenters suggested that the proposed definition could be read to capture conditional orders or IOIs that require additional negotiation or “firming up” to be executable by the broker-dealer, 152 and several commenters asserted that such conditional trading interest is distinguishable from an actionable IOI and therefore shoul [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2018-24423. Public record. Not legal advice.