Forefront Communications

FinOps Report: SEC’s New Rule 606: Execution Transparency At a Cost

Amanda Perrucci

Amanda Perrucci

For brokerage trade operations, compliance and IT managers, giving fund managers a lot more details about where and how their trades were executed to fulfill the US Securities and Exchange Commission’s enhancements to Rule 606 could turn into a major operational headache.

At issue is how much data broker-dealers have readily available, how much they have to track down, and how they will compile the results. The SEC has not clearly defined some of the elements it wants and given that the deadline for complying with the new Rule 606 is May 20, broker-dealers don’t have much time to spare. Trade operations, compliance and IT directors will need to quickly get their acts together.

The new Rule 606 will be regrouped into two reports: one called 606(a) 1 is for held-only orders where the trader is “held” to time or price for execution of equities and listed option contracts. The second 606(b) 3 report is focused on not-held orders where the broker-dealer has time to execute the order and can use discretion.

Meeting the requirements of Report 606(a)1 — applicable mainly to retail investors — will be straightforward with one major exception: the definition of venue is unclear for options. It is the second on-demand report, of interest to institutional investors, that is generating the most angst because of all the additional data and statistical requirements.

“It seems that the SEC’s goal for fund managers and other investors is to have a set of standardized information for broker-dealers routing decisions that can be used across the industry,” says Michael Post, vice president of BestXStats, a New York firm focused on best-execution reporting. “To do so, clients need to know more details about their orders so that they can measure their broker-dealer’s performance.”

The new 606(b)3 report, for the first time will flash a spotlight on fees paid and rebates received. Reading the new reports fund managers could weed out the “bad” broker-dealers who have clear conflicts of interest or route orders to destinations that benefit them, and not the clients. However, as is the case with all new disclosure requirements, it remains to be seen whether the ends justifies the means given all the extra work broker-dealers will have to do to gather all the additional data.

What’s At Stake

Broker-dealers must tell investors not only where they executed their orders but how: the fill rate, whether the order was executed at the mid-point of bid and offer. whether it took or provided iquidity and any fees or rebates. The problem: “Some of the required information might be included in the FIX messages used to confirm executions, while some is not,” explains Chris Montagnino, managing director in charge of the compliance practice at financial services consultancy Jordan & Jordan in New York.

It is uncertain whether broker-dealers will automatically have fee and rebate information tied to each client and each order based on the data they receive from trade venues. Montagnino says that the information received from each venue could be on an aggregate, net fee or rebate for the month rather than for each customer or transaction.

What then? Montagnino recommends that broker-dealers gather an inventory of all venues routed to and review the types of details provided by the venues including fees and rebates. Broker-dealers should be asking themselves the following questions: Is the information provided by symbol or client; does the information include whether the trade is a liquidity taker or provider; and does the individual trade include the amount of fees and rebates.

Once broker-dealers know where they stand, they have two options, says Montagnino. They can either take the information now provided by the trading venues through the messages in the FIX protocol, combine it with the applicable rates charged by each venue and calculate the execution costs themselves. Alternatively, broker-dealers can ask the trading venues to help provide that information.

It is more likely that broker-dealers will end up doing all the work on their own. “It all comes down to having the right market data and documentation,” says Venu Palaparthi, the chief compliance officer of Dash Financial Technologies, a New York-based executing broker offering real-time order routing and trade analytics. “Knowing how the trade was executed requires having contemporaneous market data. It amounts to information around the time the trade was executed, on which venue, whether it was sent to downstream broker-dealers, relied on third-party algorithms and the fees and rebate schedules of each trading venue.”

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