Ted,
Thanks for getting back to me.
SEC rules 11AC1-5 and 11AC1-6 were published together and become
effective on January 30, 2001.
You can see both rules in their entirety here:
http://www.sec.gov/rules/final/34-43590.htm
Final Rule: Disclosure of Order Execution and Routing Practices
The document lays out not only the details of the rules, but the
reason for their coming into being, and the benefits anticipated from
putting them into place.
Several of the questions you asked can be answered directly by
excerpting text from the above link, and I have presented these
below...in each case, the citation for the excerpt would be the rule
itself, but it is not paginated in a manner that allows for more
explicit page citations.
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What is the summary of each of the two rules
SUMMARY: The Securities and Exchange Commission is adopting two rules
to improve public disclosure of order execution and routing practices.
Under Rule 11Ac1-5, market centers that trade national market system
securities will be required to make available to the public monthly
electronic reports that include uniform statistical measures of
execution quality. Under Rule 11Ac1-6, broker-dealers that route
customer orders in equity and option securities will be required to
make publicly available quarterly reports that, among other things,
identify the venues to which customer orders are routed for execution.
In addition, broker-dealers will be required to disclose to customers,
on request, the venues to which their individual orders were routed.
By making visible the execution quality of the securities markets, the
rules are intended to spur more vigorous competition among market
participants to provide the best possible prices for investor orders.
Why are the rules in effect...?
The Securities and Exchange Commission ("Commission") is adopting two
rules to increase the visibility of execution quality of the U.S.
securities markets for public investors.1 Market centers that execute
investor orders will be required to make monthly disclosures of basic
information concerning their quality of executions. Broker-dealers
will be required to disclose the identity of the market centers to
which they route orders on behalf of customers. Taken together, the
rules should significantly improve the opportunity for public
investors to evaluate what happens to their orders after they submit
them to a broker-dealer for execution...
...The rules arise out of the Commission's extended inquiry into
market fragmentation - the trading of orders in multiple locations
without interaction among those orders. In today's markets, investor
order flow in the same security can be divided among many different
"market centers" -- e.g., exchanges, over-the-counter ("OTC") market
makers, and electronic communications networks ("ECNs"). The primary
structural component linking these market centers in the national
market system is the consolidated public quote. Pursuant to Commission
rules, the best displayed bid and offer for each equity security are
collected from all significant market centers and disseminated to the
public on a real-time basis. This centralized source of information,
however, may convey an inaccurate impression of the significant extent
to which the quality of order execution can vary across different
market centers. At some market centers, for example, as many as 50% of
certain orders, particularly market orders for small sizes (less than
500 shares), are executed at prices better than the public quotes.
Similarly, for investors seeking to use limit orders to obtain better
prices than the public quotes, there can be wide variations among
market centers in the opportunity for such orders to be executed.
...At present, few market centers provide detailed public disclosure
concerning their execution quality. Rule 11Ac1-5 will assure that all
market centers publicly disclose, on a monthly basis, basic
standardized information concerning their handling and execution of
orders...
...To complement the improved public disclosure of execution quality
by market centers, the Commission also is adopting a rule to improve
disclosure of order routing by broker-dealers. Under Rule 11Ac1-6,
broker-dealers that route orders as agent on behalf of their customers
will be required to disclose, on a quarterly basis, the identity of
the market centers to which they route a significant percentage of
their orders. Broker-dealers also will be required to disclose the
nature of their relationships with such market centers, including any
internalization or payment for order flow arrangements, that could
represent a conflict of interest between the broker-dealer and its
customers. In the past, such information has been available, if at
all, only by individual customer request on a
transaction-by-transaction basis. As a result, there has been very
little opportunity for the public to evaluate the routing practices of
a broker-dealer as a whole.
...what is the benefit for the industry?
...In a fragmented market structure with many different market centers
trading the same security, the order routing decision is critically
important, both to the individual investor whose order is routed and
to the efficiency of the market structure as a whole. The decision
must be well-informed and fully subject to competitive forces.
Currently, given the lack of comparable public information on
execution quality, retail investors may conclude that the most
rational strategy is simply to opt for a broker-dealer that offers the
lowest commission and a fast execution. As a result, there may be
limited opportunities for market participants to compete on their
ability to obtain the best prices for these investor orders. By
increasing the visibility of order execution and routing practices,
the rules adopted today are intended to empower market forces with the
means to achieve a more competitive and efficient national market
system for public investors...
...In considering the issue of fragmentation, the overriding objective
of the Commission's inquiry has been quite pragmatic - to assure that
investors receive the best possible prices for their orders...
-----
Costs and Benefits of Rule 11Ac1-5
...By improving public disclosure of execution quality, the Commission
anticipates that the Rule will help broker-dealers fulfill their duty
of best execution. That duty requires a broker-dealer to seek the most
favorable terms reasonably available under the circumstances for a
customer's order. Routing orders to a market center that merely
guarantees an execution at the best published quote does not
necessarily satisfy that duty; best execution is a facts and
circumstances determination.
...The Commission also believes that the reporting required by Rule
11Ac1-5 will facilitate investors' ability to evaluate the quality of
order executions provided by different market centers and to have
meaningful input into how their broker-dealer executes their orders.
Differences in execution quality across market centers can be very
important to investors. For example, a difference in execution price
of 1/16th for a 1000 share order can equal a savings of $62.50 for an
investor. Currently, investors possess few tools to compare order
executions on different markets, and they typically leave routing
decisions to their broker-dealer.
...The Commission believes that Rule 11Ac1-5 will have the additional
benefit of stimulating competition between market centers to improve
the quality of their executions. Market centers compete to attract
order flow. An important way in which market centers seek to attract
order flow is by providing - and developing a reputation for providing
- superior executions. The Rule will give broker-dealers and investors
meaningful information, which they have not previously had, bearing on
execution quality.
...Another potential benefit of reduced transactions costs is a
reduction in the cost of capital applied to new investments. Amihud
and Mendelson (1986)provide both theoretical and empirical evidence
that lower relative spreads are associated with lower required
returns. Further, their empirical conclusions are supported by Brennan
and Subrahmanyam (1996). The intuition behind these studies is simple:
in considering how much they are willing to pay for securities up
front, investors consider how much of the future value will be lost to
transaction costs...
-----
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Costs and Benefits of Rule 11Ac1-6
...The Commission anticipates that improved disclosure of order
routing practices will result in better-informed investors, will
provide broker-dealers with more incentives to obtain superior
executions for their customer orders, and will thereby increase
competition between market centers to provide superior executions.
...The order routing disclosures of Rule 11Ac1-6, when combined with
the execution quality disclosure made by market centers, will allow
investors to monitor the extent to which, in choosing execution
venues, there are, in fact, systematic trade-offs that must be made
between price and other factors, and the amount of those trade-offs.
-----
Who is subject to the rule?
...Paragraph (b)(1) of Rule 11Ac1-5 provides that every market center
shall make available for each calendar month an electronic report on
the covered orders in national market system securities that it
received for execution from any person. Thus, the Rule is limited in
scope to market centers, covered orders, and national market system
securities.
...Paragraph (a)(14) of the Rule defines the term "market center" as
any exchange market maker, OTC market maker, alternative trading
system, national securities exchange,35 or national securities
association.
...The definition of "covered order" in paragraph (a)(8) of Rule
11Ac1-5 contains several conditions and exclusions that are intended
to limit its scope to those orders that provide a basis for meaningful
and comparable statistical measures of execution quality. First, the
Rule applies only to market orders or limit orders that are received
by a market center during regular trading hours and, if executed,
executed during such time.
...Two types of orders warrant further discussion. The first type --
immediate-or-cancel orders -- is included in the Rule. The second -
orders to be executed at a market opening price - is excluded for
operational reasons, notwithstanding the significant issues of quality
of disclosure for investors submitting these orders, particularly in
Nasdaq securities.
...Rule 11Ac1-5 applies only to securities that are designated as
national market system securities under Exchange Act Rule 11Aa2-1.
Currently, this designation applies to exchange-listed equities and
equities included in the National Market tier of Nasdaq.44 It does not
apply to Nasdaq SmallCap securities, Over-the-Counter Bulletin Board
securities, and exchange-listed options.
...The scope of Rule 11Ac1-6 is broader than the scope of proposed
Rule 11Ac1-5. First, Rule 11Ac1-6 covers a wider range of securities.
The definition of "covered security" in paragraph (a)(1) includes not
only national market system securities (i.e., exchange-listed equities
and Nasdaq National Market equities), but also Nasdaq SmallCap
equities and listed options.61 Second, the Rule applies to all
broker-dealers that route orders on behalf of their customers. The
term "customer order" is defined as any order to buy or sell a covered
security that is not for the account of a broker-dealer. It excludes,
however, any order for a quantity of a security having a market value
of at least $50,000 for a covered security that is an option contract
and a market value of at least $200,000 for any other covered
security. Large orders are excluded in recognition of the fact that a
general overview of order routing practices is more useful for smaller
orders that tend to be homogenous.
...Finally, Rule 11Ac1-6 applies to all types of orders (e.g.,
pre-opening orders and short sale orders), but broker-dealers must
give an overview of their routing practices only for "non-directed
orders." Paragraph (a)(5) defines a non-directed order as any customer
order other than a directed order. Paragraph (a)(3) defines a directed
order as a customer order that the customer specifically instructs the
broker-dealer to route to a particular venue for execution.
What is the compliance fine if not complied with?
[Note from pafalafa-ga: No specific penalties or fines for
non-compliance are specified in the rule. However, the SEC has broad
authority under its existing mandates to impose restrictions and/or
penalties on the firms it regulates, and can go so far as to revoke
the licenses of firms to engage in further trading activities.]
Who governs over the rules?
[The Securities and Exchange Commission (SEC) is the US government
body with oversight for these rules. The specific contact information
that is provided for the two rules is as follows]:
FOR FURTHER INFORMATION CONTACT:
Susie Cho, Attorney
(202) 942-0748
Division of Market Regulation
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-1001
What is needed to comply with the rule?
-----
Required Information
...Paragraph (b)(1) of Rule 11Ac1-5 requires market center reports to
be categorized by individual security, order type, and order size.
These categories are defined in paragraphs (a)(4) through (a)(6) of
the Rule. The five types of orders are market, marketable limit,
inside-the-quote limit, at-the-quote limit, and near-the-quote limit.
The four buckets of order size are 100-499, 500-1999, 2000-4999, and
5000 or more shares. With this degree of categorization, a market
center will, for example, produce statistical information for the
subcategory of market orders for 100-499 shares in an individual
stock.
-----
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Information Required for All Types of Orders
...For each subcategory of security/order type/order size, paragraph
(b)(1)(i) specifies eleven columns of information that must be
provided. The first five columns provide general information on the
orders received by a market center in a subcategory and the
disposition of those orders. The first column is "the number of
covered orders." The second, however, is "the cumulative number of
shares of covered orders"; and thereafter all statistics required by
the Rule are expressed either in number of shares or in share-weighted
amounts. The Rule uses share-based statistics primarily to deal with
those situations in which a single order receives less than a full
execution or more than one partial execution.
...The Rule requires disclosure of the number of shares cancelled
prior to execution,49 and the number of shares executed at both the
receiving market center and at any other venue (after being routed
elsewhere by the receiving market center). Thereafter, all statistical
measures of order execution for a market center will encompass both
orders that were executed at the receiving market center and orders
that were executed elsewhere.
-----
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Information Required for Market and Marketable Limit Orders
...Subparagraph (b)(1)(ii) of Rule 11Ac1-5 specifies an additional
nine columns of information for subcategories of market orders and
marketable limit orders. These columns are intended to help evaluate
how well these orders are executed by comparing their execution prices
with the consolidated BBO at the time of order receipt. The time of
order receipt is used rather than the time of order execution
primarily based on an understanding that customers, at least for
purposes of evaluating execution quality, generally expect orders to
be executed at prices that reflect, as closely as possible, the
displayed quotes at the time they submit their orders. The earliest
time at which a market center can be held responsible for executing an
order is the time of receipt.
...Under Rule 11Ac1-6 as adopted, a broker-dealer that routes orders
on behalf of customers will be required to prepare quarterly reports
that disclose the identity of the venues to which it routed orders for
execution. The reports also will disclose the nature of the
broker-dealer's relationship with those venues, including the
existence of any internalization or payment for order flow
arrangements. Finally, broker-dealers will be required to disclose, on
customer request, where they routed a customer's individual orders for
execution.
...Paragraph (b)(1) of the Rule 11Ac1-6 requires broker-dealers to
make publicly available for each calendar quarter a report on its
routing of non-directed orders in covered securities. The term "make
publicly available" is defined to require broker-dealers to do three
steps -- post on a free Internet web site, furnish a written copy on
request, and notify customers at least annually that a written copy
will be furnished on request. The Commission expects that the
broker-dealer quarterly reports on order routing will be of direct
interest to investors, and so is requiring that broker-dealers make
them readily available via the Internet. In addition, a primarily
Internet method of dissemination will ease the burden of compliance on
broker-dealers by reducing paperwork and costs. The reports must be
provided on request for customers that may lack Internet access.
...Rule 11Ac1-6 as adopted requires that a quarterly report be divided
into four separate sections for four different types of covered
securities -- one for equity securities listed on the NYSE, one for
equity securities qualified for inclusion in Nasdaq, one for equity
securities listed on the Amex or any other national securities
exchange, and one for options. These sections reflect potentially
significant differences in routing practices for the four types of
securities and should enhance the usefulness of the quarterly reports
to investors. For each of these four sections, paragraphs (b)(1)(i)
and (ii) of the Rule require broker-dealers to give a quantitative
description of the aggregate nature of their order flow. In this
respect, Rule 11Ac1-6 is unlike Rule 11Ac1-5, which requires market
centers to categorize their orders on a security-by-security basis. As
noted above, the quarterly reports on order routing are intended to
provide a general overview of a broker-dealer's practices that is
accessible and useful to individual investors. Broker-dealers are
free, however, to disclose any additional information concerning their
order routing practices that they believe will be helpful to
customers.
...A broker-dealer's quantitative description of order routing must
include the percentage of total customer orders for a particular
section that were non-directed orders, and the percentages of total
non-directed orders for a section that were market orders, limit
orders, and other orders. This general description of a
broker-dealer's order flow should facilitate customer understanding of
its routing practices. For example, a customer may use the reports to
evaluate whether the broker-dealer specializes in the type of orders
that the customer typically uses. The quantitative description also
will include the identity of the ten venues to which the largest
number of non-directed orders for the section were routed for
execution, as well as any venue to which five percent or more of
non-directed orders were routed.
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Where is the data obtained?
[The data for the required reports are obtained from the market firms
themselves, and reflect the actual data from the trades. There is
not, to my knowledge, a single industry-wide source of data, or a
standard used by all firms. If you feel you need additional
information on this particular aspect of the rule, please let me know
what additional information you would like...pafalafa-ga]
Can any firm start offering this service to the industry?
[The rules themselves regulate market traders. They are not aimed at
the many firms that service the market-trading industry. I presume
that any competent firm could offer a data-management and reporting
service, as long as they met any other regulatory requirements that
apply to their business]
Are there any other firms that are commercially offering services for
these two rules in the US Equities Market?
Yes, although there were not that many that I found.
Two additional firms are:
http://www.25oz.com/cases.html
Trading Insight
http://www.sungard.com/products_and_services/sts/group_news/sungardlaunchesmanagementcompliance.htm
SunGard Trading Systems
Will Reg NMS have any implication to these two rules once Reg NMS is
put into effect?
REg NMS is only in the proposal stage, so there is no way to know for
certain what the final rule will look like, and to what extent it
impacts obligations under 11AC1-5 and 11AC1-6.
However, the current proposed rule can be seen in its entirety here:
http://www.sec.gov/rules/proposed/34-49325.htm
Regulation NMS
Proposed rules and amendments to joint industry plans.
and, as you can see from the language of the proposal, there is only a
very minor impact on the two rules you asked about, but in essence,
the two rules remain unchanged.
Here are the most relevant excerpts:
...the Commission is proposing to adopt two new terms, ?NMS security?
and ?NMS stock,? which would replace some terms that would be
eliminated. These terms are necessary to maintain distinctions between
current NMS rules that apply to equity securities and ETFs only (e.g.,
Exchange Act Rules 11Ac1-4 and 11Ac1-5) and those that apply to equity
securities, ETFs, and options (e.g., Exchange Act Rules 11Ac1-1 and
11Ac1-6).
...In proposed Regulation NMS, the Commission would renumber and, in
some cases, rename the current NMS rules...
...Rule 605: Disclosure of Order Execution Information (renumbers
Exchange Act Rule 11Ac1-5, the substance of which would remain largely
intact);
...Rule 606: Disclosure of Order Routing Information (renumbers
Exchange Act Rule 11Ac1-6, the substance of which would remain largely
intact)...
===============
I trust this information fully answers your question.
However, please don't rate this answer if you find you need additional
information. Just post a Request for Clarification to let me know,
and I'm at your service.
All the best,
pafalafa-ga
search strategy -- Google searches on:
11AC1-5
11AC1-6
11AC1-5 OR 11AC1-6 reporting tool
11AC1-5 OR 11AC1-6 best execution analysis |
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