The SEC’s Enhanced Order Routing Disclosures: How New Disclosures Shed Light on Rebates Paid to Broker-Dealers (Part One of Three)

Beginning in May 2019, hedge fund managers that trade National Market System (NMS) stocks will have access to significantly more disclosures regarding broker-dealer order handling as a result of the SEC’s sweeping amendments to Rule 606 of Regulation NMS under the Securities Exchange Act of 1934. Although fund managers do not have any direct obligations under Rule 606, these new disclosures will assist fund managers that trade NMS securities in evaluating their broker-dealers’ order routing practices, quality of execution and potential conflicts of interest. Additionally, SEC examiners and institutional investors are likely to ask how fund managers are incorporating this data into their best execution reviews. This first article in our three-part series provides background on the evolution of the equity market structure; existing Rule 606 disclosure requirements; the types of incentives – including payment for order flow, rebates and the “maker-taker” fee model – that exchange and non-exchange markets provide to executing broker-dealers; and ways the “pass-through” fee structure that some fund managers pay to their executing brokers differs from the “all-in” commission fee structure. The second article will examine the amended Rule 606(a) reports and new Rule 606(b)(3) reports. The third article will outline how fund managers should incorporate these new disclosures into their best execution reviews and transaction cost analyses. See “Misrepresentations About Dark Pool Participants and Order Routing Cost Citi Entities Nearly $13 Million in Recent SEC Settlement” (Nov. 1, 2018).

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