prepare Rule 605 of their behalf would result in an annualized
ongoing cost of $36,000 per respondent. See supra section VI.D. The
Commission uses the higher of these costs in the present analysis to
obtain a more conservative estimate of potential costs.
---------------------------------------------------------------------------

(1) Compliance Costs Related To Expanding the Scope of Rule 605
Reporting Entities
    As a result of the proposed amendments expanding the scope of Rule
605 reporting entities, market centers and broker-dealers that were
previously not required to publish Rule 605 reports would incur initial
costs to develop the policies and procedures to prepare Rule 605
reports for the first time, and ongoing costs to continue to prepare
them each month. Larger broker-dealers would incur initial and ongoing
compliance costs as a result of the proposed amendment expanding the
scope of Rule 605 reporting entities to include large broker-dealers.
Similarly, the proposed amendments requiring reporting entities to
prepare separate reports for their SDPs and qualified auctions would
similarly result in market centers that were previously not required to
prepare Rule 605 reports facing initial and ongoing compliance costs.
The Commission estimates that 85 broker dealers, along with 10 SDPs and
8 qualified auctions,\963\ would be required to start publishing Rule
605 reports as a result of the proposed amendments expanding the scope
of Rule 605 reporting entities. Table 10 breaks down the initial and
ongoing compliance costs associated these three types of reporting
entities.
---------------------------------------------------------------------------

    \963\ See supra note 483 and accompanying text for a discussion
of these estimates. See also infra section VII.E.1.(a) for a
discussion of estimating the number of larger broker-dealers (i.e.,
broker-dealers that introduce or carry customers above a threshold
number of customer accounts), that would be required to prepare
execution quality reports pursuant to Rule 605, defining the
customer account threshold as 100,000 customer accounts.

        Table 10--Estimated Compliance Costs Related to Proposed Expansion of Rule 605 Reporting Entities
----------------------------------------------------------------------------------------------------------------
                                                                                Initial         Ongoing
                                                                     Number of      compliance      compliance
                                                                    respondents        costs           costs
                                                                                (million)       (million)
----------------------------------------------------------------------------------------------------------------
Broker-Dealers..................................................          \a\ 85        \b\ $3.1        \c\ $3.2
SDPs............................................................          \d\ 10         \b\ 0.4         \c\ 0.4
Qualified Auctions..............................................           \e\ 8         \b\ 0.3         \c\ 0.3
                                                                 -----------------------------------------------
    Total.......................................................             103             3.8            3.9
----------------------------------------------------------------------------------------------------------------
Table 10: Estimated Compliance Costs Related to Proposed Expansion of Rule 605 Reporting Entities. This table
  presents estimates of the compliance costs related to the proposed amendments to Rule 605 expanding the scope
  of reporting entities. Numbers are based on the estimated number of respondents and PRA costs in sections VI.C
  and VI.D supra and have been rounded to the nearest tenth of million to avoid false precision.
\a\ The number of new broker-dealer respondents is estimated using data from 2021 FOCUS Report Form X-17A-5
  Schedule I filings and CAT, according to the procedure described in detail in infra note 1008.
\b\ The estimate of initial compliance costs to new respondents is based on the monetized initial burden in
  supra note 491 for new respondents, assuming that these respondents would incur 100 initial burden hours at an
  average hourly cost of ($37,020/100 hours) = $370.20 per respondent per hour.
\c\ The estimate of ongoing compliance costs to new respondents is based on the monetized annual burden in supra
  note 492 for new respondents, assuming that these respondents would incur 8 ongoing burden hours per month (12
  per year) at an average hourly cost of ($37,488/(8 hours * 12 months)) = $391.00 per respondent per hour.
\d\ The Commission does not have knowledge of the number of SDPs in operation and there has chosen a
  conservative estimate of 10 SDPs.
\e\ The Commission is not able to know the number of qualified auctions that would begin operation if the Order
  Competition Rule Proposal were to be adopted, and has therefore chosen a conservative estimate of 8 qualified
  auctions.

    New reporters would face one-time, initial compliance costs to
develop and implement the policies and procedures to prepare Rule 605
reports for the first time. The Commission believes that the majority
of these costs would relate to the development of systems to obtain,
store and process the data required for Rule 605 reports.
    Larger broker-dealers that generally or exclusively route orders
away would need to obtain information, such as the time of order
execution and execution price, from trade confirmations provided by the
execution venue. In addition, both broker-dealers and market centers
would need to match their order information to historical price and
depth information available via the exclusive SIPs or, following the
implementation of the MDI Rules, competing consolidators,\964\ to
determine the NBBO (and/or best displayed) quote and size at the time
of order receipt (or executability) and at the time of order execution,
and use this data to calculate the required statistics.\965\ These new
reporters likely already retain most, if not all, of the underlying raw
data necessary to generate these reports in electronic format or may
obtain this information from publicly available data sources, and
currently calculate similar measures to those that would be required
under Rule 605 as proposed for their own internal purposes.\966\
However, as a result of the proposed amendments, new reporters may have
to acquire or develop data specialists and/or programmers to the extent
that the information required by Rule 605 as proposed is different or
more complex than the information that the new reporters typically
processes, and/or acquire legal specialists to ensure compliance with
the Rule.
---------------------------------------------------------------------------

    \964\ See supra section VII.C.1.(d)(2).
    \965\ See supra note 196 and accompanying text.
    \966\ For example, broker-dealers may calculate similar measures
as part of their Best Execution Committees' periodic review. See
supra note 567 and accompanying text.

---------------------------------------------------------------------------

    These compliance costs related to expanding the scope of Rule 605
reporting requirements may be under- or overestimated to the extent
that larger broker-dealers, which are assumed to have the same
compliance costs as SDPs and qualified auctions in Table 10, could
experience higher or lower initial and/or ongoing costs than other
types of reporting entities. For example, larger broker-dealers may
incur higher initial costs to the extent that they do not currently
obtain transaction information, such as the time of order execution and
execution price, from trade confirmations provided by execution venues,
and therefore would need to develop the procedures for doing so.
Broker-dealers may also face higher ongoing costs as compared to market
centers that mostly execute the shares that they receive, if collecting
information for trades executed at away market centers is costlier than
analyzing in-house trade information; e.g., because it results in
delays in processing the trade information. On the other hand, larger
broker-dealers may incur lower initial costs if they are more likely
than market centers to already calculate similar measures to those
proposed as part of their Best Execution Committees' periodic
review.\967\ In addition, the Commission does not believe that there
would be significant additional costs to collecting information for
trades executed at away market centers, as given the monthly reporting
frequency of Rule 605 reports, broker-dealers should have sufficient
time to collect and process the information. Since it is not possible
to determine whether larger broker-dealers would face higher or lower
compliance costs than other types of market centers, the Commission is
conservatively estimating that broker-dealers will incur the same
compliance costs as other types of reporting entities.
---------------------------------------------------------------------------

    \967\ See supra note 567 and accompanying text.
---------------------------------------------------------------------------

    Furthermore, many of the larger broker-dealers that would be newly
included in the scope of reporting requirements already have experience
with filing Rule 605 reports; e.g., because they operate an ATS, engage
in market making, or are otherwise affiliated with market centers that
currently files Rule 605 reports.\968\ Likewise, SDPs and qualified
auctions could also have lower initial costs to the extent that they
are operated by market centers that are currently required to publish
Rule 605 reports. In both cases, these reporting entities could
leverage this experience to prepare the reports for these additional
lines of businesses more cost effectively.
---------------------------------------------------------------------------

    \968\ For example, based on larger broker-dealers' answers in
their Q4 2021 FOCUS Report Form X-17A-5 Schedules I and II, staff
estimates that 29 out of the 85 broker-dealers identified as
introducing or carrying at least 100,000 customers also engage in
OTC or specialist market making activities. Specifically, 20 of
these larger broker-dealers answered ``Yes'' to item 8075 of
Schedule I, asking whether a respondent is registered as a
specialist on a national securities exchange in equity securities,
16 of them reported non-missing gains or losses from OTC market
making in exchange listed equity securities in item 3943 of Schedule
II, while 7 of them reported both OTC and specialist equity market
maker activities.
---------------------------------------------------------------------------

(2) Compliance Costs Related to Modifications to the Coverage of Orders
and Information Required by Rule 605 Reports
    As a result of the proposed amendments modernizing and expanding
the coverage of orders and information required by Rule 605 reports,
reporting entities would incur initial compliance costs and additional
ongoing compliance costs.\969\ First, the estimated 236 current
reporters \970\ would incur initial costs to update their systems to
collect and store new information and to calculate modernized and
additional metrics, as well as a potential increase in ongoing costs as
a result of additional data that would need to be collected and stored.
Second, the proposed amendment expanding the coverage of order sizes
included in Rule 605 to include orders for less than one share would
result in an additional estimated 20 market centers that trade
exclusively in fractional shares would be required to begin filing Rule
605 reports.\971\ Third, the 16 national securities exchanges and 1
national securities association would be required to amend the NMS Plan
to account for the new data fields required to be reported. Table 11
breaks down the associated initial and ongoing compliance costs.
---------------------------------------------------------------------------

    \969\ This analysis considers the baseline against which to
compare the costs that would accrue to larger broker-dealers, SDPs,
and qualified auctions to be a world in which do not have to publish
Rule 605 reports, and not a world in which these reporting entities
are required to publish Rule 605 under current reporting
requirements. As such, this section does not consider the cost of
the proposed amendments modifying the coverage and information
required by Rule 605 to those reporting entities that would begin
publishing Rule 605 reports as a result of the proposed amendments
expanding the scope of Rule 605 reporting entities.
    \970\ See supra note 483 and accompanying text for a discussion
of these estimates.
    \971\ These market centers are identified using the CAT data
described in supra note 644, as firm MPIDs that executed fractional
shares during the sample time period that did not have a
corresponding Rule 605 report. These firms are relatively large,
with an average net capital of $1.66 billion, which is similar to
the average net capital of all larger broker-dealers that meet the
customer account threshold of at least 100,000 customer accounts
($1.59 billion). In fact, the Commission estimates that 16 of the
markets centers that exclusively execute fractional shares are also
larger broker-dealers that meet the customer account threshold.
Under proposed Rule 605(a)(7), to the extent that a market center
that exclusively executes fractional shares is also a broker-dealer
that meets or exceed the customer account threshold, then this
reporting entity would be required to file separate Rule 605 reports
pertaining to each function. See supra note 166.

 Table 11--Estimated Compliance Costs Related to Proposed Amendments Modifying the Information Required by Rule
                                                       605
----------------------------------------------------------------------------------------------------------------
                                                                                Initial         Ongoing
                                                                     Number of      compliance      compliance
                                                                    respondents        costs           costs
                                                                                (million)       (million)
----------------------------------------------------------------------------------------------------------------
Costs to Current Reporters......................................         \a\ 236        \b\ $2.6        \c\ $1.1
Costs to Market Centers Trading Fractional Shares...............          \d\ 20         \e\ 0.7         \f\ 0.7
Cost to NMS Plan Participants to Update Data Fields.............          \g\ 17        \h\ 0.06           \i\ 0
                                                                 -----------------------------------------------
    Total.......................................................             272             3.4             1.9
----------------------------------------------------------------------------------------------------------------
Table 11: Estimated Compliance Costs Related to Proposed Amendments Modifying the Information Required by Rule
  605. This table presents estimates of the compliance costs related to the proposed amendments to Rule 605
  modifying the coverage of orders and information required by Rule 605 reports. Numbers are based on the
  estimated number of respondents and PRA costs in sections VI.C and VI.D supra and have been rounded to the
  nearest tenth of million to avoid false precision.

\a\ The number of current respondents includes 16 national securities exchanges, 1 securities association, 32
  ATSs (based on the number of effective Form ATS-N filings), and an estimated 93 OTC market makers and 94
  exchange market makers (based on firms' responses on their 2021 FOCUS Report Form X-17A-5 Schedules I and II).
\b\ The estimate of initial compliance costs to current respondents is based on the monetized initial burden in
  supra note 488 for current respondents, assuming that these respondents would incur 30 initial burden hours as
  a result of the amendments at an average hourly cost of ($18,510/50 hours) = $370.20 per respondent per hour.
\c\ The estimate of ongoing compliance costs to current respondents is based on the monetized annual burden in
  supra note 489 for current respondents, assuming that these respondents would incur 1 additional ongoing
  burden hours per month (12 per year) as a result of the amendments at an average hourly cost of ($37,488/(8
  hours * 12 months)) = $391.00 per respondent per hour.
\d\ The Commission does not have knowledge of the number of market centers currently trading in fractional
  shares that would newly be required to prepare Rule 605 reports, and has therefore chosen a conservative
  estimate of 20 firms.
\e\ The estimate of initial compliance costs to new respondents (in this case, market centers that would newly
  be required to prepare Rule 605 reports as a result of trading fractional shares) is based on the monetized
  initial burden in supra note 491 for new respondents, assuming that these respondents would incur 100 initial
  burden hours at an average hourly cost of ($37,020/100 hours) = $370.20 per respondent per hour.
\f\ The estimate of ongoing compliance costs to market centers that would newly be required to prepare Rule 605
  reports as a result of trading fractional shares is based on the monetized annual burden in supra note 492 for
  new respondents, assuming that these respondents would incur 8 ongoing burden hours per month (12 per year) at
  an average hourly cost of ($37,488/(8 hours * 12 months)) = $391.00 per respondent per hour.
\g\ The number of NMS plan participants includes 16 national securities exchanges and 1 securities association.
\h\ The estimate that the monetized initial burden for preparing and filing an amendment to the NMS Plan would
  include approximately $40,222 in aggregate internal costs per participants as well as an aggregate external
  cost of $16,864 resulting from outsourced legal work. See supra section VI.D.
\i\ The Commission estimates that the costs related to updating data fields would be a one-time cost, and thus
  would not incur any additional ongoing compliance costs.

    As a result of the proposed amendments, current Rule 605 reporters
would incur initial compliance costs to update their systems to collect
and store new information.\972\ For example, current Rule 605 reporters
would need to expand their data collection systems to include
additional order types, such as stop orders, short sale orders, and
orders submitted outside of regular trading hours, and would need to
update their systems to reclassify certain orders, such as IOCs,
riskless principal orders, and beyond-the-midpoint NMLOs, into new or
different order type categories. Similarly, current reporters would
need to expand their data collection systems to incorporate additional
order sizes, including odd-lots, fractional orders, and larger-sized
orders.
---------------------------------------------------------------------------

    \972\ The Commission assumes that the majority of reporting
entities' initial burden hours under the PRA would be spent updating
current systems as a result of the many changes to Rule 605, and
thus estimate that 30 of the 50 initial burden hours estimated for
current respondents and described in supra note 488 would be
allocated to compliance with the proposed amendments modifying the
information contained in Rule 605.
---------------------------------------------------------------------------

    Current Rule 605 reporters would also incur initial compliance
costs to update their data processing software to generate modernized
and additional metrics. For example, current Rule 605 reporters would
need to update their methodologies for calculating realized spread,
first, to include two measures, and, second, to calculate the realized
spread using 15 second and 1 minute horizons, instead of 5 minutes, and
would need to develop programs (i.e., code) to calculate newly required
metrics, such as E/Q. Some of the metrics would involve matching trade
information to data elements that are not currently required by Rule
605 but that can be obtained from public data sources, such as the best
displayed price for calculating the proposed new price improvement
metrics,\973\ and the number of shares displayed at the NBBO for
calculating the benchmark measure related to size improvement.\974\ To
the extent that they do not already do so, current Rule 605 reporters
would also need to update their systems to record timestamps in terms
of milliseconds rather than seconds as a result of the proposed
amendment increasing the granularity of time-to-execution metrics.
---------------------------------------------------------------------------

    \973\ See supra section IV.B.5 for a discussion of the data
required to calculate this measure.
    \974\ See supra section IV.B.4.(e) for a discussion of the data
required to calculate this measure.
---------------------------------------------------------------------------

    The Commission believes that, after current Rule 605 reporters
update their systems to reflect the amendments, changes to their
ongoing costs would be limited, as the process for generating and
publishing Rule 605 reports would largely be unchanged.\975\ This is
because most reporting entities currently retain most, if not all, of
the underlying raw data necessary to generate the additional data
elements, or are easily able to obtain this information from publicly
available data sources. Furthermore, once reporting entities have
developed the necessary programs to calculate the required metrics,
there is limited additional effort that needs to be made beyond what
current reporters are already doing, such as monitoring and debugging
these statistical programs. However, the Commission recognizes that
there may be some additional ongoing costs to the extent that some
metrics introduced under the proposed amendments may require more data
storage or more complex calculations, such that the cost of preparing
monthly Rule 605 reports may increase. Therefore, the Commission has
allocated addition ongoing costs to account for this possibility.\976\
---------------------------------------------------------------------------

    \975\ One exception is the proposed amendment requiring
reporting entities to prepare summary reports summarizing key
information from their Rule 605 reports. The Commission assumes that
current reporters would face additional ongoing costs as a result of
this amendment, and discuss these costs in infra section
VII.D.2.(a)(3).
    \976\ Specifically, one additional ongoing monthly burden hour
per respondent has been added to account for this possibility. See
footnote to Table 11.
---------------------------------------------------------------------------

    As a result of the proposed amendment expanding the scope of Rule
605 to include information about orders for less than one share, the
Commission estimates that some broker-dealers that exclusively execute
fractional shares, and therefore do not currently file Rule 605 reports
in their capacity as a market center due to fractional shares falling
below the smallest order size category in current Rule 605, would be
required to begin publishing Rule 605 reports. These broker-dealers
would incur similar initial and ongoing costs as those discussed above
for larger broker-dealers, SDPs, and qualified auctions that would be
included as a result of the expanded scope of reporting entities. These
compliance costs may be over- or underestimated if broker-dealers that
exclusively execute fractional shares have different characteristics
(e.g., fewer customers) than the larger broker-dealers that would be
included as a result of the expanded scope of reporting entities.
    Lastly, the Commission estimates that the 16 national securities
exchanges and 1 national securities association would incur a one-time
initial cost to amend the NMS Plan to account for the new data fields
required to be reported. The Commission estimates that this would
mostly consist of legal time to develop

and draft the amendments to the NMS Plan.
(3) Compliance Costs Related to the Proposed Summary Execution Reports
    The estimated 236 current Rule 605 reporters \977\ would face
additional initial and ongoing compliance cost as a result of the
proposed amendment requiring reporting entities to prepare summary
reports summarizing key information from their Rule 605 reports.\978\
Table 12 breaks down the initial and ongoing compliance costs
associated with this amendment.
---------------------------------------------------------------------------

    \977\ This section does not consider the cost of the proposed
amendments to those reporting entities that would begin publishing
Rule 605 reports as a result of the proposed amendments expanding
the scope of Rule 605 reporting entities. See explanation in supra
note 969.
    \978\ The Commission believes that a significant portion of
reporting entities' initial burden hours under the PRA would be
allocated to updating current systems to prepare summary reports,
which would entail both a new format and a new level of information
aggregation as compared to current Rule 605, and thus estimate that
20 of the 50 initial burden hours estimated for current respondents
and described in supra note 488 would be allocated to compliance
with the proposed amendments modifying the information contained in
Rule 605.

 Table 12--Estimated Compliance Costs Related to Proposed Amendment Requiring Summary Execution Quality Reports
----------------------------------------------------------------------------------------------------------------
                                                                                Initial         Ongoing
                                                                     Number of      compliance      compliance
                                                                    respondents        costs           costs
                                                                                (million)       (million)
----------------------------------------------------------------------------------------------------------------
Costs to Prepare Summary Execution Quality Reports..............         \a\ 236        \b\ $1.7        \c\ $1.1
----------------------------------------------------------------------------------------------------------------
Table 12: Estimated Compliance Costs Related to Proposed Amendment Requiring Summary Execution Quality Reports.
  This table presents estimates of the compliance costs related to the proposed amendments to Rule 605 requiring
  Rule 605 reporting entities to prepare summary execution quality reports. Numbers are based on the estimated
  number of respondents and PRA costs in sections VI.C and VI.D supra and have been rounded to the nearest tenth
  of million to avoid false precision.
\a\ The number of current respondents is estimated as including 16 national securities exchanges, 1 securities
  association, 32 ATSs (based on the number of effective Form ATS-N filings), 93 OTC market makers, and 94
  exchange market makers (based on firms' responses on their 2021 FOCUS Report Form X-17A-5 Schedules I and II).
\b\ The estimate of initial compliance costs to current respondents is based on the monetized initial burden in
  supra note 488 for current respondents, assuming that these respondents would incur 20 initial burden hours as
  a result of the amendments at an average hourly cost of ($18,510/50 hours) = $370.20 per respondent per hour.
\c\ The estimate of ongoing compliance costs to current respondents is based on the monetized annual burden in
  supra note 489 for current respondents, assuming that these respondents would incur 1 additional ongoing
  burden hours per month (12 per year) as a result of the amendments at an average hourly cost of ($37,488/(8
  hours * 12 months)) = $391.00 per respondent per hour.

    The Commission estimates that these costs would be only a fraction
of the overall costs to comply with Rule 605 reporting requirements, as
they would contain only a small subset of the information published in
the fuller Rule 605 reports. However, this may underestimate costs to
the extent that these summary reports, which are intended to be human-
readable and therefore have a different format (PDF file), are costlier
to prepare and/or store than machine-readable data.\979\
---------------------------------------------------------------------------

    \979\ For example, a single letter ``a'' results in a PDF file
of 7,706 bytes vs. a TXT file of 1 byte. See, e.g., File Size, U.S.
Pat. & Trademark Office, available at https://www.uspto.gov/ebc/portal/infofilesize.htm. However, the lower information content of
the summary file PDFs likely results in lower file sizes despite the
larger per-pixel storage requirements.
---------------------------------------------------------------------------

(4) Implications of Compliance Costs for Competition
    While the Commission believes that the primary competitive effect
of the proposed amendments would be to increase competition between
reporting entities on the basis of execution quality,\980\ it is
possible that the proposed amendments would have a negative impact on
competition if the associated compliance costs described above prevent
the entry of new reporting entities or cause some entities to leave the
market.
---------------------------------------------------------------------------

    \980\ See supra section VII.D.1.(b)(1) for a discussion of the
effects of the proposed amendments on competition between reporting
entities on the basis of execution quality.
---------------------------------------------------------------------------

    The Commission is unable to quantify the likelihood that a either a
trading venue or a brokerage firm would cease operating as a result of
the compliance costs associated with the proposed amendments. While the
Commission does not believe that these compliance costs are large
enough such that this would be likely,\981\ the Commission recognizes
this possibility depends in part on whether the compliance costs
associated with Rule 605 are likely to be fixed or variable. If Rule
605 compliance costs represent a fixed cost, these costs could
represent a significant portion of a smaller reporting entity's
revenue, such that the reporting entity could become unprofitable if
subjected to these costs.\982\ This could impact competition between
reporting entities, for example, by causing some reporting entities to
leave the market, or preventing the entry of new ones. It could also
result in broker-dealers avoiding taking on more than 100,000
customers, to avoid crossing the customer account threshold such that
they would need to being complying with Rule 605 reporting
requirements.
---------------------------------------------------------------------------

    \981\ For example, data on broker-dealers' median monthly
revenues from FOCUS Report Form X-17A-5 Schedule II show that the
estimated monthly compliance cost would represent 0.09% of the
monthly revenues of broker-dealers with 100,000 customers or less,
and 0.003% of the monthly revenues of broker-dealers with 100,000
customers or more.
    \982\ The Commission does not believe that this compliance costs
are large enough such that this would be likely. See id.
---------------------------------------------------------------------------

    On the other hand, if Rule 605 compliance costs are variable, then
the scalability of compliance costs would mean that smaller reporting
entities would incur lower compliance costs related to execution
quality reports, which would mitigate some of these concerns. Rule 605
compliance costs could be variable, e.g., because smaller reporting
entities handle lower order volumes and therefore would require less
data storage and less complexity when calculating the metrics required
by Rule 605 as proposed.
    Furthermore, even if compliance costs of preparing Rule 605 reports
are fixed from the perspective of reporting entities (this would be the
case, e.g., if variable costs such as data storage are dominated by
fixed costs such as costs for compliance and data personnel), they may
be lower if reporting entities make use of third-party vendors, who can
leverage economies of scale to spread fixed costs across the
potentially many reporting entities that they

service, to prepare Rule 605 reports on their behalf. Therefore, to the
extent that reporting entities make use of third-party vendors to
prepare their Rule 605 reports, and these vendors charge reporting
entities variable report preparation fees (e.g., based on the amount of
data), this could lead to data vendors charging lower prices to prepare
the Rule 605 reports of smaller reporting entities. This would also
reduce the burdens of compliance costs for smaller reporting entities.
    However, even if some smaller reporting entities were to exit, the
Commission does not believe this would significantly impact competition
in either the market for brokerage services or the market for trading
services, because both markets are served by a large number of
competitors.\983\ The Commission recognizes that smaller reporting
entities may have unique business models that are not currently offered
by competitors, but the Commission believes a competitor could create
similar business models if demand were adequate.
---------------------------------------------------------------------------

    \983\ See supra section VII.C.3.(a)(1) for a discussion of the
structure of the market for brokerage services, and supra section
VII.C.3.(a)(2) for a discussion of the structure of the market for
trading services.
---------------------------------------------------------------------------

(b) Other Potential Costs
    The Commission has preliminarily identified costs in addition to
compliance costs that some market participants may incur as a result
from the proposed amendments. Many of these costs are difficult to
quantify, especially as the practices of market participants are
expected to evolve and may change due to the information on execution
quality that is required to be reported under the proposed amendments
to Rules 605. Therefore, much of the following discussion is
qualitative in nature.
(1) Costs to Reporting Entities of Improvements to Execution Quality
    In addition to compliance costs, the proposed amendments could
result in costs to some reporting entities based on how market
participants adjust their behavior in response to increased
transparency and competition on the basis of execution quality.\984\
---------------------------------------------------------------------------

    \984\ See supra Section VII.D.1.(b)(1) for a discussion on how
the proposed amendments would increase competition on the basis of
execution quality. The costs to reporting entities associated with
increased transparency and competition on the basis of execution
quality would likely represent a transfer from these reporting
entities to other market participants.
---------------------------------------------------------------------------

    First, increased transparency and competition on the basis of
execution quality, and subsequent scrutiny by customers and other
market participants, might make broker-dealers less likely to route
orders based on payment relationships and/or fees and rebates. While
this would likely benefit customers in the form of better execution
quality, if broker-dealers were to reduce the order flow sent to
wholesalers who pay for it, the broker-dealers would receive less
payment for such order flow and might pass the lost payments on to
their customers, for example, by raising brokerage commissions or other
fees. Similarly, if broker-dealers were to route orders to trading
centers with lower rebates and higher fees, they might pass the
reduction in rebate revenue and increase in fee costs on to their
customers, for example, by raising brokerage commissions or other fees.
Broker-dealers may pass lost payments or revenues along to customers in
other ways as well, for example by reducing the quality of some bundled
services or paying a lower interest rate on deposit accounts.
    Second, increased competition on the basis of execution quality may
result in costs to reporting entities to the extent that they need to
update or improve their routing or execution systems in order to remain
competitive. However, should these improvements result in improved
execution quality for investors, any costs to a reporting entity of
improvements to their routing or execution systems would be offset by
benefits to other market participants, i.e., investors.
    It is possible that the capital expenditure associated with such an
upgrade may be such that some reporting entities would no longer remain
profitable. The Commission is unable to estimate the number of
reporting entities that may leave the market as a result of no longer
being able to compete with other reporting entities on the basis of
execution quality. However, the Commission does not believe this would
significantly impact competition in either the market for brokerage
services or the market for trading services, because both markets are
served by a large number of competitors and that, if a reporting entity
were to exit for this reason, these markets would be served by more
efficient firms that are better able to offer execution quality to
customers in line with its industry peers.
(2) Costs for Smaller Broker-Dealers
    There may be additional costs to the proposed amendments if smaller
broker-dealers, who would not be subject to Rule 605 reporting
requirements under the proposed amendments but may face competitive
pressure to provide customers with more information and execution
quality, would also face initial and ongoing costs to provide customers
with execution quality reports.\985\ The costs for smaller broker-
dealers to prepare execution quality reports may not be the same as the
costs for larger broker-dealers. Smaller-broker dealers may lack the
technical expertise and compliance experience of larger broker-dealers,
which would tend to lead to higher costs; however, smaller broker-
dealers may also have lower costs if their lower order volume and
customer account numbers lead to less complexity when calculating the
metrics required in the reports.
---------------------------------------------------------------------------

    \985\ See infra section VII.D.1.(d)(1) for a discussion of the
impact of the proposed amendments on smaller broker-dealers.
---------------------------------------------------------------------------

(3) Potential for Less Transparency
    The proposed amendments expanding the set of Rule 605 reporting
entities to include larger broker-dealers could impose a cost on
broker-dealer customers if those broker-dealers that currently
voluntarily provide their customers with execution quality reports stop
providing these reports, which potentially contain more or different
information than what the proposed amendments require.\986\ Some
broker-dealer customers, especially institutional investors, currently
request reports about the handling of their orders from their broker-
dealers.\987\ These reports may be less or more detailed and provide
different and potentially less or potentially more information than
those required by Rule 605 as proposed to be amended. To the extent
that these reports are more detailed or provide more information than
Rule 605 as proposed to be amended, and to the extent that broker-
dealers would be less incentivized to provide these reports to their
customers as a result of the proposed amendments,\988\ broker-dealer
customers may have access to less information as a result of the
proposed amendments. The Commission preliminarily believes that this
scenario is not very likely because customers could still request
additional information or customized reports from

their broker-dealers and broker-dealers may be incentivized to satisfy
such requests, to the extent they currently do, to retain their
customers.\989\
---------------------------------------------------------------------------

    \986\ These reports could include, for example, public reports
prepared according to the FIF Template (see supra note 450), or
private ad hoc reports the broker-dealers prepare for their
customers (see discussion in section VII.C.1.(c)(2) supra).
    \987\ See supra section VII.C.1.(c)(2) for a discussion of the
practice of institutional investors requesting execution quality
reports from their broker-dealers.
    \988\ Note that this does not apply to broker-dealer's
requirements to provide customers with execution quality information
about their not held orders.
    \989\ See, e.g., 2018 Rule 606 Amendments Release, 83 FR 58338
(Nov. 19, 2018) at 58403, which discusses a similar potential cost
and further notes that the willingness of broker-dealers to provide
such customized reports to customers and the level of detail in such
a report might depend on the business relationship between the
broker-dealer and the customer, such as whether the customer does a
large amount of business with the broker-dealer.
---------------------------------------------------------------------------

(4) Potential for Lower Execution Quality
    The Commission acknowledges that, to the extent that the proposed
amendments to Rule 605 fail to capture relevant dimensions of execution
quality or cause market participants to focus on some dimensions of
execution quality to the detriment of others, the proposed amendments
may reduce execution quality along certain dimensions that may be
relevant to some investors. The nature of execution quality as a multi-
faceted concept has been a focus of academic papers, which have pointed
out that execution quality is composed of multiple aspects or
dimensions, including price and speed, among others.\990\ As stated by
the Commission in the Adopting Release, different investors may have
different concerns and priorities related to execution of their
orders.\991\ If the proposed amendments tend to favor certain
dimensions of execution quality while excluding or neglecting others,
there is a possibility that certain investor groups may be advantaged
by the proposed amendments to the disadvantage of other investor
groups.
---------------------------------------------------------------------------

    \990\ See, e.g., Robert Battalio, Brian Hatch & Robert Jennings,
All Else Equal?: A Multidimensional Analysis of Retail, Market Order
Execution Quality, 6 J. Fin. Mkt. 143 (2003); Ekkehart Boehmer,
Dimensions of execution quality: Recent evidence for US equity
markets, 78 J. Fin. Econ. 553 (2005); Emiliano S. Pagnotta & Thomas
Philippon, Competing on Speed, 86 Econometrica 1067 (2018).
    \991\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75432.
---------------------------------------------------------------------------

    For example, average effective spreads calculated for NMLOs capture
the portion of the spread that is earned by liquidity providers and
paid by liquidity demanders.\992\ If reporting entities compete for
NMLOs by offering a wider effective spread, NMLO execution prices would
improve at the expense of the execution prices of the marketable
orders. There is a similar trade-off between, e.g., time-to-execution
and execution prices for NMLOs, as a broker-dealer seeking to improve
the time-to-execution of NMLOs may favor routing those orders to an
inverted venue where, as marketable orders earn a rebate, it may be
more likely to attract a counterparty; this could incentivize trading
venues to compete on rebates rather than on execution quality. Another
example would be, if size improvement becomes a major driver of order
flow, national securities exchanges may try to incentivize hidden
liquidity and broker-dealers may route orders to venues with higher
expected hidden orders, as size improvement measures mechanically
benefit from a greater degree of hidden volume.\993\ It is possible
that incentivizing hidden liquidity at the cost of displayed orders may
negatively impact market quality by obfuscating trading interest
information and discouraging trade by making order books look thinner
than they actually are.
---------------------------------------------------------------------------

    \992\ See supra note 709 and accompanying text for a discussion
of the interpretation of average effective spreads for NMLO.
    \993\ For example, if two exchanges have 200 shares available at
the NBO price but one exchange is hiding a portion of this interest,
a market order to purchase 200 shares would record size improvement
on the venue with hidden liquidity but wouldn't on the other venue.
---------------------------------------------------------------------------

(5) Costs To Update Best Execution Methodologies
    As a result of the proposed amendments, financial service providers
that are subject to best execution obligations \994\ would likely
reevaluate their best execution methodologies to take into account the
availability of new statistics and other information that may be
relevant to their decision making. This may impose a cost only to the
extent that broker-dealers and/or investment advisers choose to build
the required statistics into their best execution methodologies. The
proposed amendments do not, however, address and therefore do not
change the existing legal standards that govern financial service
providers' best execution obligations.\995\
---------------------------------------------------------------------------

    \994\ See supra notes 565-566 and accompanying text.
    \995\ See supra note 69.
---------------------------------------------------------------------------

3. Economic Effects on Efficiency, Competition, and Capital Formation
(a) Efficiency
    The Commission preliminarily believes the proposed amendments to
Rule 605 would improve the efficiency of analyzing 605 reports, which
would result in improved price efficiency. Price efficiency would
improve as a result of improvements in order execution quality that
would result from increased transparency and thus competition. As
investors would benefit from improved execution quality as a result of
the proposed amendments, these investors would also likely benefit from
lower transaction costs. Transaction costs reflect the level of
efficiency in the trading process, with higher transaction costs
reflecting less efficiency and more friction, which limits the ability
for prices to fully reflect a stock's underlying value.\996\ Academic
literature defines friction in financial markets to measure ``the
difficulty with which an asset is traded,'' \997\ and as ``the price
paid for immediacy.'' \998\ Friction makes it more costly to trade and
makes investing less efficient, and it limits the ability of
arbitrageurs or informed customers to push prices to their underlying
values. Thus, friction makes prices less efficient. The proposed
amendments to Rule 605 would improve order execution quality and reduce
transaction costs. This, in turn, would reduce financial frictions and
improve price efficiency.
---------------------------------------------------------------------------

    \996\ See Hans R. Stoll, Friction, 55 J. Fin. 1479 (2000).
    \997\ See id.
    \998\ See Harold Demsetz, The Cost of Transacting, 82 Q. J.
Econ. 33 (1968).
---------------------------------------------------------------------------

(b) Competition
    As previously discussed in the benefits section of this economic
analysis, the Commission believes that the proposed amendments to Rule
605 would facilitate competition on the basis of execution quality in
the markets for brokerage services and trading services.\999\ The
proposed amendments may also have additional effects on competition,
such as increasing the extent to which Rule 605 reporting entities
compete within other quality areas (such as rebates and transaction
fees), and increasing competition in related markets (such as the
market for TCA).
---------------------------------------------------------------------------

    \999\ See supra section VII.D.1.(b)(1) for a detailed discussion
of the effects of the proposed amendments on competition in these
markets on the basis of execution quality.
---------------------------------------------------------------------------

(1) Competition in Other Areas
    An increase in the extent to which Rule 605 reporting entities
compete on the basis of execution quality as a result of the proposed
amendments may also spill over to increase incentives to compete along
other lines, i.e., reduce fees or increase rebates (including PFOF), or
offer new products or functionalities to attract customers.
    First, national securities exchanges may be incentivized to
increase rebates or lower fees as a result of the proposed amendments.
Exchanges compete on the basis of fees and rebates to incentivize
broker-dealers to route more order flow to them.\1000\ If an exchange
offers the

same execution quality as another reporting entity, an exchange may be
incentivized to lower its transaction fees or raise its rebates in
order to increase its competitive position in attracting more customers
or order flow.\1001\ To the extent that this occurs and to the extent
that the resulting lower fees or higher rebates would be passed on to
investors, this could be beneficial for investors.
---------------------------------------------------------------------------

    \1000\ See supra section VII.C.3.(b)(2) for a discussion of
competition between national securities exchanges on the basis of
fees and rebates.
    \1001\ Another possibility is that a reporting entity that
offers inferior execution quality may try to compete on the basis of
lower fees or higher rebates instead of increasing its execution
quality. To the extent that this occurs, this may limit the extent
to which competition would lead to improved execution quality for
the customers of these reporting entities. However, these customers
would still benefit from the lower fees or higher rebates.
---------------------------------------------------------------------------

    Reporting entities may also be incentivized to innovate to offer
new products in order to compete. For example, some broker-dealers may
be incentivized to differentiate themselves by offer new
functionalities that appeal to customers, such as the ability to trade
on margin, in additional asset classes, such as options, or trade
fractional shares.\1002\
---------------------------------------------------------------------------

    \1002\ See, e.g., supra note 642, describing how trading volume
increased substantially for brokers after they introduced the use of
fractional shares.
---------------------------------------------------------------------------

(2) Competition in Related Markets
    Second, the proposed amendments to Rule 605 could also have an
impact on markets other than brokerage and trading services, such as
the market for TCA. For example, suppose that a customer chooses to no
longer purchase TCA once Rule 605 reports as proposed to be amended
become available, because the customer decides that the information
contained in the reports is sufficient. If fewer customers purchase
TCA, this would have a negative impact on the market for third-party
providers of TCA as well as third-party data vendors, because of a
reduction in the demand for their services. Further, the quality of TCA
provided by third parties may decrease because third-party providers of
TCA might have fewer resources for the development and maintenance of
their product offerings and because with fewer customers, third-party
providers may have less data to use to build their models. At the same
time, the quality of TCA reports may also improve if their publishers
need to offer better products in order to compete with the publicly
available data, and/or use the expanded information available under the
proposed amendments to Rule 605 to offer new or better products.
(c) Capital Formation
    The Commission preliminary believes the proposed amendments to Rule
605 may promote capital formation by improving price efficiency. As
discussed above, the proposed amendments would improve order execution
quality and reduce transaction costs, which would improve price
efficiency. Improved price efficiency would cause firms' prices to more
accurately reflect their underlying values, which may improve capital
allocation and promote capital formation.
    Financial frictions may have an adverse impact on capital
formation. In particular, higher transaction costs may hinder
customers' trading activity that would support efficient adjustment of
prices and, as a result, may limit prices' ability to reflect
fundamental values. Less efficient prices may result in some issuers
experiencing a cost of capital that is higher than if their prices
fully reflected underlying values, and in other issuers experiencing a
cost of capital that is lower than if their prices accurately reflected
their underlying value, as a result of the market's incomplete
information about the value of the issuer. This, in turn, may limit
efficient allocation of capital and capital formation.
    By improving order execution quality and reducing transaction
costs, the proposed amendments would reduce financial frictions and
promote investor's ability to trade. This would have the effect of
promoting capital formation through improved price efficiency.

E. Reasonable Alternatives

1. Reasonable Alternative Modifications to Reporting Entities
(a) Different Customer Account Thresholds for Differentiating Larger
Broker-Dealers
    The Commission also considered alternatives to the proposed
amendment to require larger broker-dealers \1003\ to prepare execution
quality reports pursuant to Rule 605 and exclude broker-dealers that
introduce or carry less than a threshold number of customer accounts,
defining the customer account threshold as 100,000 customer
accounts.\1004\ Lowering this threshold would increase the total costs
of the proposed amendments, as more broker-dealers would be subject to
the costs of preparing Rule 605 reports; however, lowering the
threshold may also be beneficial if more broker-dealer customers are
able to benefit from the proposed modifications to reporting
entities.\1005\ On the other hand, raising the customer account
threshold would lower the total costs of the proposal, but may result
in fewer broker-dealer customers benefiting from the proposed
modifications to reporting entities.
---------------------------------------------------------------------------

    \1003\ See supra note 1 defining the term ``larger broker-
dealers.''
    \1004\ See supra note 166 and accompanying text discussing the
proposed customer account threshold.
    \1005\ See supra section VII.D.1.(d)(1) for a discussion of the
extent to which excluding smaller-brokers dealers (i.e., those
broker-dealers with customer accounts numbers below the customer
account threshold) limits the benefits of the enhanced reporting
requirements on competition for customer order flow.
---------------------------------------------------------------------------

    In order to examine the number of broker-dealers that would be
subject to the collection of information obligations of Rule 605 as a
result of the proposed modifications to reporting entities for
different levels of the customer account threshold, it is necessary to
estimate the number of customers for both carrying and introducing
broker-dealers.\1006\ In order to estimate the number of carrying
broker-dealers' customers, the Commission used data from broker-
dealers' 2021 FOCUS Report Form X-17A-5 Schedule I, which asks
respondents whether they carry their own public customer accounts,
along with the number of carrying broker-dealers' public customer
accounts.\1007\ In order to estimate the number of introducing broker-
dealers' customers, the Commission used data from CAT during the
calendar year 2021 on the number of unique customer accounts whose
trades are associated with broker-dealers that do not identify as
carrying their own public customer accounts in FOCUS Report Form X-17A-
5 Schedule I.\1008\ The resulting customer numbers

are then used to estimate the number of both carrying and introducing
broker-dealers that would be subject to the reporting requirements of
Rule 605 as proposed, using various different definitions of the
customer account threshold. The estimated costs of the proposed
amendments from the various definitions of the customer account
thresholds are then calculated using the estimated initial and ongoing
costs for new Rule 605 filers.\1009\
---------------------------------------------------------------------------

    \1006\ See supra note 736 and accompanying text for a definition
of carrying and introducing broker-dealers.
    \1007\ Specifically, item 8080 asks for information on
``respondent's total number of public customer accounts,'' but only
broker-dealers that are carrying firms are requiring to answer this
question, so information on introducing broker-dealers' customers is
not included.
    \1008\ Customer accounts are identified in CAT as accounts
belonging to either the ``Institutional Customer'' account type,
defined as accounts that meet the definition in FINRA Rule 4512(c),
or the ``Individual Customer'' account holder type, defined as
accounts that do not meet the definition of FINRA Rule 4512(c) and
are also not a proprietary account. See supra note 609 for more
information about account types in CAT. Broker-dealers are
identified according to their FDID as defined in section 1.1 of the
CAT NMS Plan. Introducing broker-dealers are identified as those
broker-dealers that report trades by customer accounts in the CAT
dataset and do not identify as carrying their own public customer
accounts in FOCUS Report Form X-17A-5 Schedule I. However, a
customer account is only observed in this dataset if it actually
traded during the sample period from January to December 2021.
Therefore, to the extent that there are customer accounts that did
not trade during this period, these accounts would be missing from
our sample. In order to adjust for these missing accounts, an
adjustment factor was constructed based on the assumption that, for
carrying broker-dealers identified in both FOCUS and CAT, the number
of customer accounts associated with the broker-dealer in CAT
represents some percentage of that broker-dealer's total customer
base available from FOCUS (i.e., those customer accounts that
actually traded during 2021). Dividing the number of accounts from
CAT by the number of customer accounts from FOCUS reveals that, on
average, around 29% of these broker-dealers' customer accounts
traded during 2021. Observed customer numbers from CAT are then
scaled up using the adjustment factor of 1/0.29 to estimate of the
total number of customers for each broker-dealer (both carrying and
introducing). In order to ensure that our estimate of customer
account numbers is as conservative as possible, if a broker-dealer
is observed in both datasets, the number of customers for that
broker-dealer is taken as the higher of their customer account
number reported in FOCUS and the adjusted number of customers
estimated from CAT. Note that this method may underestimate the
total number of customers to the extent that carrying broker-dealers
identified in FOCUS introduce customers that they do not carry (see
supra note 736 discussing hybrid carrying/introducing broker-
dealers), and/or that introducing broker-dealers would have a higher
or lower adjustment factor than carrying broker-dealers. This method
may also underestimate or overestimate any particular broker-
dealer's total number of customers to the extent that a larger or
smaller portion of the broker-dealer's customer base traded during
the sample period than the number implied by the adjustment factor.
Lastly, this method may underestimate the number of customer
accounts to the extent that some broker-dealers introduce customer
accounts on an omnibus basis, which pool together the accounts of
potentially multiple underlying customers but would only be recorded
as a single account in CAT.
    \1009\ See supra section VI.D for a description of these costs.
See supra notes 488 and 489 for initial and ongoing costs for
existing respondents; and supra notes 491 and 492 for initial and
ongoing costs for new respondents. This analysis assumes the same
costs for both larger and smaller broker-dealers.
---------------------------------------------------------------------------

    Lowering the customer account threshold may be beneficial if more
broker-dealer customer accountholders are able to benefit from the
enhanced reporting requirements. In order to estimate the benefits of
different customer account thresholds, the Commission calculated the
cumulative number of customer accounts (expressed as a percentage of
all identified carrying and introducing broker-dealer customer
accounts) associated with broker-dealers that would be subject to the
reporting requirements of Rule 605 as proposed according to various
definitions of the customer account threshold. Similarly, using
estimates of the number of transactions associated with the broker-
dealers' customer accounts, the Commission calculated the cumulative
number of customer orders (expressed as a percentage of all customer
orders belonging to carrying and introducing broker-dealer customer
accounts) associated with broker-dealers that would be included under
the various thresholds.\1010\
---------------------------------------------------------------------------

    \1010\ Specifically, the Commission used the total number of
transactions associated with the broker-dealer customer accounts
identified in CAT during calendar year 2021, along with the sum of
broker-dealers' responses to items 8107 and 8108 from their 2021
FOCUS Report Form X-17A-5 Schedule I (``Number of respondent's
public customer transactions: equity securities transactions
effected on a national securities exchange'' and ``equity securities
transactions effected other than on a national securities
exchange''). See Focus Report Form X-17A-5 Schedule I, SEC,
available at https://www.sec.gov/files/formx-17a-5_schedi.pdf. Note
that some of these orders are likely to be excluded from Rule 605
reporting requirements to the extent that they belong to an order
type or size group that is not subject to Rule 605. In order to
ensure that our estimate of customer transactions is as conservative
as possible, if a broker-dealer is observed in both datasets, the
number of customer transactions for that broker-dealer is taken as
the higher of the number of transactions as reported in FOCUS and
the number of transactions observed in CAT.
---------------------------------------------------------------------------

    Table 13 presents the estimated number of broker-dealers (both
carrying and introducing) that would be subject to Rule 605 reporting
requirements according to different customer account thresholds, the
resulting estimated costs of the proposed amendments, and the resulting
estimated benefits in terms of the cumulative percentage of included
customer accounts and orders. The table shows that increasing the
customer account threshold from 100,000 to 500,000 would reduce the
costs of the proposed amendments by around 47%, but would also result
in lower coverage of customer transactions and accounts. In particular,
only 6.2% of the customer transactions observed in 2021 would be
included. Meanwhile, reducing the customer account threshold from
100,000 to 10,000 would almost triple both initial and ongoing costs.
The amount of included transactions would increase by an additional
14.8 percentage points, which would be beneficial. However, the
percentage of included customer accounts increases only marginally, by
1.2 percentage points, implying that the additional customer coverage
resulting from the lower threshold is associated with only a small
number of accounts that trade in large volumes. Such accounts are
likely to belong to institutional traders, who are likely to have
access to alternative information about the execution quality achieved
by their broker-dealers and/or are likely to make use of not held
orders that are excluded from Rule 605 reporting requirements, and
would therefore be less likely to depend on Rule 605 reports for
information about their broker-dealers' execution quality.\1011\
Therefore, lowering the customer account threshold to include these
customers may not be particularly beneficial, especially when compared
to the substantial increase in cost.
---------------------------------------------------------------------------

    \1011\ See supra section VII.C.1.(c)(2) for a discussion of
institutional investors' access to alternative sources of execution
quality other than Rule 605 reports.
---------------------------------------------------------------------------

Table 13--Cost-Benefit Analysis of Different Customer Account
Thresholds Defining ``Larger Broker-Dealers''

[GRAPHIC] [TIFF OMITTED] TP20JA23.016

    An indirect cost of requiring these smaller broker-dealers to
publish Rule 605 reports is an increased risk of information leakage.
To the extent that a broker-dealer serves multiple institutional
investors and/or these institutional investors exclusively use not held
orders, it would be difficult to identify the orders of a particular
customer in the proposed reports. However, a smaller broker-dealer may
have only a few institutional investor customers that represents the
majority of its business and this may be known to other market
participants. In this case, it may be possible to learn from Rule 605
reports some information about the customer's order flow that is
handled by the specific broker-dealer. This information would only
pertain to historical order flow and would only include a possibly
limited subset of the customer's orders that are held orders, but could
nevertheless provide information about the general characteristics of
the customer's order flow, which may be useful to other market
participants. Such a potential outcome could put smaller broker-dealers
(that is, those with a small set of customers or handling a relatively
small number of institutional orders) at a competitive disadvantage
relative to larger broker-dealers, as institutional investors might
avoid using smaller broker-dealers to avoid possible disclosure that
could be traced back to the customer.
(b) Require All Broker-Dealers To Prepare Rule 605 Reports
    Another alternative to the proposed amendment to require larger
broker-dealers to prepare execution quality reports pursuant to Rule
605 is to require all broker-dealers to prepare such reports, excluding
broker-dealers with de minimis order flow.\1012\
---------------------------------------------------------------------------

    \1012\ This alternative was suggested by EMSAC; see supra notes
104-106; 171 and accompanying text.
---------------------------------------------------------------------------

    Expanding reporting requirements to all broker-dealers, subject to
a de minimis threshold, would greatly increase the scope of the
proposed amendments, as there were 3,498 registered broker-dealers as
of Q2 2022.\1013\ However, only around a third (specifically, 1,267) of
these broker-dealers introduced or carried at least one individual and/
or institutional investor in the market for NMS stocks within the
sample time period.\1014\ The Commission is mindful of the additional
costs that broad expansion of the rule to all broker-dealers would
entail, relative to the likely limited benefits of expanding reporting
requirements to a substantial number of broker-dealers that do not
directly handle, and thus have less discretion over the execution
quality of, individual and institutional investors' orders. Therefore,
the Commission believes that the increase in cost that would accompany
a requirement for all broker-dealers to prepare Rule 605 reports,
subject to a de minimis threshold, would not be justified by the
corresponding benefit, and that limiting reporting obligations to
broker-dealers that handle customer orders would focus the associated
implementation costs on those broker-dealers for which the availability
of more specific execution quality statistics would provide a greater
benefit.
---------------------------------------------------------------------------

    \1013\ See supra note 735 and corresponding discussion.
    \1014\ See analysis in supra Table 13 for estimated number of
broker-dealers that introduce or carry at least one customer
account.
---------------------------------------------------------------------------

(c) Defining the Threshold for Differentiating Larger Broker-Dealers
Using Number of Customer Transactions Rather Than Number of Customer
Accounts
    The Commission also considered defining the threshold for
differentiating larger broker-dealers using number of customer
transactions rather than number of customer accounts. An approach
requiring that broker-dealers handling above a threshold level of
customer transactions publish Rule 605 reports would likely capture an
overall larger number of customer orders. However, it would also be
subject to a

number of issues that would limit the benefits of this approach.
    First, this approach would likely exclude from reporting
requirements broker-dealers that have a large number of relatively
inactive customer accounts, and include broker-dealers that have a
small number of accounts associated with large amounts of trading
volume. While the former are likely to be accounts belonging to
individual investors, the latter are very likely to be institutional
accounts. Institutional investors are likely to have access to
alternative information about the execution quality achieved by their
broker-dealers and/or are likely to make use of not held orders that
are excluded from Rule 605 reporting requirements, and would therefore
be less likely to depend on Rule 605 reports for information about
their broker-dealers' execution quality.\1015\ Meanwhile, individual
investors have few alternatives other than Rule 605 for information
about the execution quality achieved by their broker-dealers.\1016\
Therefore, while expanding overall coverage, defining the threshold
using the number of customer transactions would be less likely to
target the types of orders that may be most useful for consumers of
Rule 605 reports.
---------------------------------------------------------------------------

    \1015\ See section VII.C.1.(c)(2) for a discussion of
institutional investors' access to alternative sources of execution
quality other than Rule 605 reports.
    \1016\ See section VII.C.1.(c)(1) for a discussion of individual
investors' usage of Rule 605 reports.
---------------------------------------------------------------------------

    Secondly, defining the threshold using the number of customer
transactions may result in a less stable classification of broker-
dealers into those that are and are not subject to Rule 605
requirements, as there is likely to be more month-to-month variation in
transaction numbers resulting from changes in market conditions, as
compared to number of customer accounts.\1017\ This could potentially
be disruptive to broker-dealers to have to coordinate compliance with
the Rule during some periods but not others and interfere with
customers' or market participants' ability to look at a broker-dealer's
execution quality over time by analyzing historical data. Furthermore,
the dependence of transaction volumes on market conditions may result
in broker-dealers being newly defined as ``larger broker-dealers''
subject to reporting requirements, even though their size relative to
other broker-dealers did not change. For example, a period of sustained
market volatility resulting in overall increases in market activity
levels may trigger the need for many or even most broker-dealers to
file Rule 605 reports, even if the broker-dealer's relative portion of
order flow (as a percentage of total broker-dealer customer order flow)
did not change.\1018\ This would increase the total compliance costs
associated with the proposed amendments.
---------------------------------------------------------------------------

    \1017\ Note that this possibility is somewhat limited by the
proposal that a broker or dealer that equals or exceeds the customer
account threshold would be required to provide reports for at least
three calendar months. See supra note 183 and corresponding
discussion.
    \1018\ Note that this possibility would be somewhat limited by
the proposal to only require broker-dealers to publish Rule 605
reports after a three-month initial grace period. See supra note 186
and corresponding discussion.
---------------------------------------------------------------------------

    Lastly, the number of customer accounts is likely less costly for
broker-dealers to calculate and track compared to the number of
transactions associated with customer accounts. Given that only 41.1%
of customer-carrying broker-dealers report the actual number of their
customer transactions (rather than an estimated number) on their FOCUS
Report Form X-17A-5 Schedule I,\1019\ the extent to which broker-
dealers currently are able or choose to track the number of
transactions associated with their customer accounts is unclear.
---------------------------------------------------------------------------

    \1019\ See supra note 168 for a description of FOCUS Report Form
X-17A-5 Schedule I.
---------------------------------------------------------------------------

2. Reasonable Alternative Modifications to Scope of Covered Orders
(a) Explicitly Include ISO Orders With Limit Prices Inferior to the
NBBO
    Currently, marketable Intermarket Sweep Orders (``ISOs'') with a
limit price inferior to the NBBO, i.e., an ISO with a limit price less
than the national best bid for sell orders or higher than the national
best offer for buy orders, may be viewed as being subject to special
handling, which would exclude them from Rule 605 reports.\1020\ One
alternative could be to explicitly include these orders within the
scope of covered orders, either aggregated with other orders types or
as a separate order type category.
---------------------------------------------------------------------------

    \1020\ See supra notes 36-37, discussing the exclusion of orders
for which the customer requests special handling from the definition
of ``covered orders''. See also 2013 FAQs, answer to Question 1.
---------------------------------------------------------------------------

    ISOs make up a large percentage of on-exchange trade volume; one
academic working paper found that, between January 2019 and April 2021,
ISOs accounted for 48% of on-exchange trade volume.\1021\ In order to
estimate the volume of ISOs that are excluded from Rule 605 reporting
requirements as a result of the exclusion of ISOs with inferior limit
prices, an analysis was performed using data on ISO marketable limit
orders from the Tick Size Pilot B.II Market and Marketable Limit Order
dataset.\1022\ Table 14 shows that ISO orders with limit prices
inferior to the NBBO make up 4.9% of ISO buy orders (6.3% of buy share
volume), and 4.7% of ISO sell orders (9.0% of ISO sell volume).
Therefore, it could be the case that these orders make up a small but
non-negligible percent of order flow.\1023\
---------------------------------------------------------------------------

    \1021\ See Ariel Lohr, Sweep Orders and the Costs of Market
Fragmentation (Sept. 18, 2021), available at https://ssrn.com/abstract=3926296 (retrieved from SSRN Elsevier database).
    \1022\ See supra note 723 for dataset description. For the
analysis of ISO orders, the Commission limited this analysis to a
randomly selected sample of 100 stocks and for the time-period of
March 2019.
    \1023\ As the Tick Size Pilot covered only small-cap stocks
(i.e., NMS common stocks that have a market capitalization of $3
billion or less, a closing price of at least $2.00, and a
consolidated average daily volume of one million shares or less),
ISO volumes and properties may be different for mid- or large-cap
stocks. Furthermore, as the Tick Size Pilot data is based on self-
reported data by trading centers, there is the possibility that the
data may be subject to certain errors or omissions.

Table 14--Marketable Intermarket Sweep Orders by Price Relative to NBBO,
                               March 2019
------------------------------------------------------------------------
                                                             ISO sell
                                          ISO buy orders      orders
                                             (percent)       (percent)
------------------------------------------------------------------------
Percent of Orders:
    Price Equal to the NBBO.............            95.1            95.2
    Price Worse Than NBBO...............             4.9             4.7
    Price Better Than NBBO..............            0.05            0.06
Percent of Share Volume:
    Price Equal to the NBBO.............            93.5            90.1
    Price Worse Than NBBO...............             6.3             9.0

    Price Better Than NBBO..............             0.2             0.9
------------------------------------------------------------------------
Table 14: Marketable Intermarket Sweep Orders by Price Relative to NBBO,
  March 2019. This table shows the percentage of ISO marketable limit
  orders with limit prices inferior to the NBBO, equal to the NBBO, and
  better than the NBBO, using a randomly selected sample of 100 stocks
  from the Tick Size Pilot B.II Market and Marketable Limit Order
  dataset and for the time period of March 2019. See supra note 723 for
  dataset description. The numbers reported here, in particular those
  related to the NBBO, may change once the amendments in the MDI
  Adopting Release are implemented. See supra note 613 and section
  VII.C.1.(d)(2).

    However, there are questions as to whether ISOs with inferior limit
prices would be comparable to other marketable limit orders. When the
limit price of an ISO is inferior to the NBBO at time of order receipt,
the customer is effectively instructing the trading center that it can
execute the order at a price inferior to the NBBO. If the order
executes, any adverse effects that this inferior limit price has on the
order's execution quality metrics (e.g., a negative price improvement,
or a higher effective spread) would be a result of the customer's
instructions, rather than the market center or broker-dealer's
discretion. As a result, these orders are likely to skew execution
quality metrics downwards if included with other order types, which
would harm market participants' ability to use these metrics to
accurately compare reporting entities.
    One alternative could be to explicitly include ISOs with inferior
limit prices as a separate order type category in Rule 605 reports.
However, the instruction that a market center should execute an ISO
order at a price inferior to the NBBO, even when other market centers
are displaying liquidity at better prices, limits broker-dealers'
discretion over the execution price of these orders. Thus, market
participants may only benefit from this information to the extent that
market centers or broker-dealers still have some discretion over some
dimension of the order's execution quality such that this information
would be useful in comparing metrics across reporting entities. For
example, the willingness of traders to accept prices worse than the
NBBO could help illuminate the premium paid by traders to quickly trade
in a fragmented trading environment, which could differ across market
centers.
(b) Exclude Orders That Are Cancelled Quickly After Submission
    Limit orders that are canceled within a very short amount of time
after submission are likely driven by trading strategies (for example,
high frequency trading \1024\ and ``pinging'') that are not intended to
provide liquidity, and therefore may have limited information about the
execution quality of a particular market center. Excluding quickly
cancelled orders from the definition of covered orders may allow fill
rates (i.e., number of shares executed at or away from the market
center, divided by number of covered shares) to better capture the
execution probability of resting orders that are given a minimum
opportunity to be executed, leading to a more meaningful ranking of
Rule 605 reporting entities. At the same time, excluding cancelled
orders also may entail losing important information if these
cancellations capture information about orders that did not or could
not receive a fill, rather than trading strategies.
---------------------------------------------------------------------------

    \1024\ The Concept Release on Equity Market Structure states
that ``the submission of numerous orders that are cancelled shortly
after submission'' is a primary characteristic of high-frequency
traders. See 75 FR 3594 (Jan. 21, 2010) at 3606.
---------------------------------------------------------------------------

    In order to examine how the presence of quickly cancelled orders
may impact fill rates and subsequently impact the ranking of market
centers, the Commission first examined data on cancellation and
execution times of executable NMLOs from MIDAS during the month of
March 2022.\1025\ Figure 16 plots the conditional distribution of
cancellation and execution times,\1026\ and shows that cancellation
times tend to be shorter than execution times: while the largest
percentage (29.8%) of cancelled executable NMLOs are cancelled between
1 and 100 milliseconds after submission, the largest percentage (44.8%)
of executable NMLOs that received execution are not executed until
between 1 and 30 seconds after submission. In fact, while 75% of
cancelled orders are cancelled in less than 1 second, only 41.1% of
executions happen within the same time frame. This imbalance implies
that many orders may be cancelled before they are given a reasonable
opportunity to execute.
---------------------------------------------------------------------------

    \1025\ See supra note 634 for data description. Note that this
analysis doesn't include IOC NMLOs, which are not captured in MIDAS
metrics. As discussed in supra section VII.C.2.(c)(7), these orders
may also contribute to low fill rates in Rule 605 reports.
    \1026\ Note that the conditional distribution examines the
percentage of cancelled (executed) orders that are cancelled
(executed) within the defined time thresholds, and not the
percentage of all orders that are cancelled or executed within the
defined thresholds. Therefore, the cancellation (execution)
percentages plotted in the Figure should sum up to 100%.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P

Figure 16: Distribution of Execution and Cancellation Times for
Executable NMLOs, March 2022

[GRAPHIC] [TIFF OMITTED] TP20JA23.017

    Therefore, it may be the case that excluding orders cancelled below
some minimum threshold may lead to more informative fill rates.
However, one question might be how to determine this threshold. For
example, if the intent is to exclude cancellations that are part of
high-frequency trading strategies such as pinging, it may be useful to
keep in mind that estimates of human reaction time range from between
one second and several hundred milliseconds, setting an upper bound for
what might be considered high-frequency trading.\1027\ Meanwhile, one
recent academic paper found that high frequency trading strategies
operate in approximately 5 to 10 microseconds.\1028\ This would imply
that a useful range for determining an appropriate threshold might be
between approximately a few microseconds and one second. Figure 17
plots the fill rates of executable NMLOs that result from excluding
orders that are cancelled below a variety of minimum time thresholds,
showing that fill rates increase and approach 100% as more and more
cancelled orders are excluded from the calculation of the fill rate.
Importantly, fill rates do not change much when orders cancelled in
less than 100 microseconds, only increasing by 0.2%. Fill rates
increase substantially when orders cancelled in less than 1 second are
excluded, but still remain on the lower side at 11.5%. This implies
that the impact of excluding quickly cancelled orders on fill rates may
be limited.\1029\
---------------------------------------------------------------------------

    \1027\ See, e.g., Neil Johnson, Guannan Zhao, Eric Hunsader,
Hong Qi, Nicholas Johnson, Jing Meng & Brian Tivnan, Abrupt Rise of
New Machine Ecology Beyond Human Response Time, 3 Sci. Reps. 1
(2013); Albert Menkveld & Marius A. Zoican, Need for Speed? Exchange
Latency and Liquidity, Rev. Fin. Stud. 1188 (2017).
    \1028\ See Matteo Aquilina, Eric Budis & Peter O'Neill,
Quantifying the High-Frequency Trading ``Arms Race, 137 Q. J. Econ.
493 (2022).
    \1029\ Note that this sample contains a mixture of stocks in
terms of share price and market capitalization, and these numbers
are likely to look different for individual stocks according to
their market capitalization and liquidity characteristics.
---------------------------------------------------------------------------

Figure 17: Effect of Excluding Quickly Cancelled Orders on Fill Rates
for Executable NMLOs, March 2022

[GRAPHIC] [TIFF OMITTED] TP20JA23.018

BILLING CODE 8011-01-C
    The benefit of excluding quickly cancelled orders is also likely to
be limited if excluding these orders systemically increases fill rates
across all reporting entities and does not necessarily lead to a change
in ranking between reporting entities. To explore this possibility, the
Commission limited the sample to the five largest market centers in
terms of execution volume, to examine how the rankings between these
market centers changes in terms of their fill rates for executable
NMLOs resulting from changes to the threshold below which to exclude
cancelled orders. Then it examined changes to their fill rate rankings
for executable NMLOs as the threshold below which to exclude cancelled
orders increased. The Commission found that market centers' rankings
did not change until cancellations below one second were excluded, when
the market centers ranked first and third switched places. As for
reasons described above one second represents a maximum bound on a
reasonable threshold for excluding cancellations, this again implies
that the benefits of excluding quickly cancelled orders on fill rates
may be limited.
(c) Include NMLOs Submitted Outside of Regular Trading Hours as a
Separate Order Category
    The Commission is proposing to include NMLOs submitted outside of
regular trading hours if they become executable during regular trading
hours into the scope of covered orders. If NMLO orders submitted
outside of regular trading hours have characteristics that are
fundamentally different from other types of orders and have sufficient
volume such that their inclusion along with other orders may skew
execution quality statistics, it may be useful to include these orders
are a separate order type category in Rule 605 reports. Pre-open orders
likely have characteristics that differ from orders submitted during
regular hours.\1030\ However, these pre-open orders make up only a very
small percentage of order volume, representing only around 4.8% of the
volume of orders submitted during a single ten-minute period of the
trading day. Therefore, it is unlikely that the inclusion of these
orders along with other order types would significantly skew execution
quality statistics, and including them as a separate order type
category would likely only increase the complexity and size of Rule 605
report files.
---------------------------------------------------------------------------

    \1030\ See supra section VII.D.1.(a)(2)(a) for an analysis
showing that orders submitted pre-open tend to be larger and further
away from the midpoint as compared to orders submitted during
regular opening hours.
---------------------------------------------------------------------------

3. Reasonable Alternative Modifications to Required Information
(a) Reasonable Alternative Order Size Categories
    (1) Defining Order Sizes Based on Dollar Volume Categories Rather
Than Number of Round Lots
    Instead of redefining order size categories according to number of
round lots, one alternative would be to redefine categories based on
the dollar value of the order. This approach has several advantages.
First, similarly to defining categories based on numbers of round lots
as in the current proposed amendments, notional size buckets based on
orders' dollar values may make it easier to compare execution quality
metrics across market centers that may trade in differently priced
stocks. Pre-controlling for the stock price would thus eliminate the
need for users of Rule 605 to go through the extra step of collecting
and controlling for stock price information before being able to
meaningful compare market centers using Rule 605 data. Secondly, unlike
categories based on numbers of round lots, which according to the MDI
Rules are based on the previous month's trading price,\1031\ categories
based on dollar volumes incorporate information about changing stock
prices in real time, thereby better grouping together similarly sized
orders, e.g., stocks that experience a large price increase or drop
within a single month.
---------------------------------------------------------------------------

    \1031\ See supra note 265 and accompanying text.
---------------------------------------------------------------------------

    On the other hand, while remaining in the spirit of distinguishing
between ``small'' and ``large'' orders, defining order size buckets
according to dollar values would no longer produce a meaningful
distinction between round lot and odd-lot orders according to the

new definitions under the MDI Rules, so it would not be possible to
distinguish orders that may not be at quotes protected under Rule 611.
Therefore, it is not clear that defining order size categories in terms
of dollar values is superior to defining them by number of round lots
as is currently proposed.
(b) Reasonable Alternative Time-to-Execution Statistics
(1) Increase the Granularity of Time-to-Execution Buckets
    One alternative to eliminating time-to-execution buckets would be
to redefine the time-to-executions to have a granularity that better
suits the speed of modern markets. Time-to-executions for both
marketable and non-marketable order types calculated using the Tick
Size Pilot B.II dataset was analyzed,\1032\ and Figure 12 shows
execution speeds of market and marketable limit orders, along with the
three categories of non-marketable limit orders currently required in
Rule 605 (inside-the-quote, at-the-quote, and near-the-quote).
---------------------------------------------------------------------------

    \1032\ See supra note 723 for dataset description.
---------------------------------------------------------------------------

    The figure shows that, for market and marketable limit orders,
time-to-execution speeds are mostly bunched up at the fastest end of
their time buckets, and the longer time-to-execution buckets are left
virtually empty. However, the figure shows a very different picture for
NMLOs, in particular for at-the-quote and near-the-quote limit orders.
In contrast to market and marketable limit orders, a vast majority of
these orders are executed in over one second.
    While the proposed amendment to include only NMLOs that eventually
touch the NBBO could cause average execution speeds to differ between
Rule 605 and that of the Tick Size Pilot, e.g., by excluding some NMLOs
with very long execution times, virtually all of the orders in the at-
the-quote category would by definition be included within the proposed
new scope of executable NMLOs. These orders also have a very different
distribution of time-to-executions compared to that of market and
marketable limit orders. Therefore, the granularity of time-to-
execution that would be granular enough to usefully capture the
execution speeds of market and marketable limit orders would likely be
too granular to capture the execution speeds of non-marketable limit
orders. One solution might be to define two different sets of time-to-
execution buckets: one for market/marketable orders, and one for non-
marketable limit orders. However, this would likely increase the
complexity of reporting requirements.
(c) Reasonable Alternative Spread Measures
(1) Use Different Clock Time Horizons To Calculate Realized Spread
    The Commission is proposing to require the realized spread to be
calculated at both 15 seconds and one minute time horizons. The
Commission also considered alternative time horizons. An ideal
measurement horizon would be one that aligns with the amount of time an
average liquidity provider holds onto the inventory positions
established from providing liquidity.\1033\ Selecting an appropriate
time horizon to calculate the realized spread is important, as realized
spreads vary significantly as the time horizon is changed, as well as
according to stock characteristics, such as size.\1034\
---------------------------------------------------------------------------

    \1033\ See supra section IV.B.4.
    \1034\ See supra Figure 1.
---------------------------------------------------------------------------

    An analysis of variations in realized spreads calculated over time
horizons ranging from 1 second to 5 minutes, as well as how they differ
based on stock size, generally showed that, by the 1-minute horizon,
realized spreads captured the majority of the information contained in
realized spreads for all stocks, and a substantial majority for the two
groups of larger stocks.\1035\ However, while increasing the time
horizon from 1 minute to 5 minutes has only a minimal impact on
realized spreads for larger stocks, for the two smaller-stock groups, a
sizeable proportion of the overall decline (37%) does not occur until
the 5-minute horizon. Therefore, it may be that retaining a 5-minute
horizon, in addition to the proposed 1-minute and 15-second horizon,
would capture additional information about realized spreads, particular
for the smallest stocks. However, requiring an additional specification
of realized spreads would entail adding another data item, which would
also increase the complexity of Rule 605 reports and thereby add to the
costs that market participants face when collecting, interpreting, and
evaluating Rule 605 reports.\1036\ Given that more than 50% of the
variation in realized spreads is already captured by the 1-minute
horizon, the Commission does not believe that this additional cost
would be justified by the benefit of requiring an additional
specification for realized spreads.
---------------------------------------------------------------------------

    \1035\ See supra Table 1.
    \1036\ See supra section VII.C.2.(d) discussing search costs
related to Rule 605 reports.
---------------------------------------------------------------------------

(2) Use Trade Time Horizons To Calculate Realized Spread
    The Commission also considered whether the time horizon used to
calculate realized spreads should be measured in terms of ``trade
time,'' rather than ``clock time.'' An ideal measurement horizon for
realized spreads would be one that aligns with the amount of time an
average liquidity provider holds onto the inventory positions
established from providing liquidity. As discussed above, one would
expect that this horizon varies according to characteristics that
impact liquidity providers' ability to turn over their positions,
including stock characteristics such as size as described above;
however, this time horizon also varies over time, as overall market
conditions change. The use of a fixed time horizon could therefore make
it so that the ability of realized spread measures to capture
information about adverse selection varies over time.
    Instead of setting a fixed ``clock time'' horizon, volume or
``trade time'' measures changes between the ``the initial trade to the
ith trade thereafter,'' \1037\ and therefore allows for a time horizon
that is flexible to different levels across stocks, and also over
different time periods. In other words, while prices may update under
liquid conditions in a few seconds or less, during very illiquid
conditions several minutes may go by without a trade. Measuring time in
terms of number of trades allow for the horizon to match these
different speed ``regimes'' and may result in realized spread
calculations that are more consistently relevant.\1038\
---------------------------------------------------------------------------

    \1037\ See Conrad and Wahal at 241.
    \1038\ For this reason, some academic studies use of trade time
instead of clock time when calculating metrics; see, e.g., David
Easley, Marcos M. Lopez De Prado & Maureen O'Hara, Flow Toxicity and
Liquidity in a High-Frequency World, 25 Rev. Fin. Stud. 1457 (2012).
---------------------------------------------------------------------------

    However, the Commission is mindful of the additional computational
resources that would be required if trade time were required to
calculate realized spreads, as it would require reporting entities to
match their execution information both to information on the NBBO, as
would be necessary under the proposed clock time horizons, but
additionally historical trade information from the exclusive
SIPs.\1039\ More computationally intensive metrics would likely
increase reporting entities' compliance costs. Therefore, the
Commission believes that the proposed amendment to include multiple
fixed time horizons (15 seconds and 1 minute) would allow for
sufficient

flexibility in capturing realized spread information for stocks and/or
time periods with different liquidity characteristics without
increasing the computational resources required to calculate this
measure.
---------------------------------------------------------------------------

    \1039\ See supra note 195.
---------------------------------------------------------------------------

(3) Use Weighted Midpoint To Calculate Effective and Realized Spread
    Rule 600(b)(9) currently defines effective spreads as, for buy
orders, double the amount of difference between the execution price and
the midpoint of the national best bid and national best offer at the
time of order receipt and, for sell orders, as double the amount of
difference between the midpoint of the national best bid and national
best offer at the time of order receipt and the execution price.\1040\
The Commission is further proposing to add a definition of the average
percentage effective spread, which would be equal to the share-weighted
average of effective spreads, divided by the midpoint.\1041\ However,
an academic study \1042\ found that measuring the effective spread
relative to the midpoint overestimates effective spreads by an average
of 13%-18%, and that the bias can vary across stocks, trading venues,
and investor groups. The paper instead suggests measuring effective
spreads relative to a weighted midpoint, which factors in the depth
available at the best bid and ask price, in order to reduce this
bias.\1043\
---------------------------------------------------------------------------

    \1040\ See 17 CFR 242.600(b)(8).
    \1041\ See proposed Rule 600(b)(11).
    \1042\ See Bj[ouml]rn Hagstr[ouml]me, Bias in the Effective Bid-
Ask Spread, 142 J. Fin. Econ. 314 (2021).
    \1043\ See supra note 419 for a precise definition of the
weighted midpoint.
---------------------------------------------------------------------------

    The presence of bias in effective spreads in Rule 605 reports would
impact market participants' ability to use this metric to make
comparisons across reporting entities, particularly if the bias leads
to a systematic over- or under-estimation of spreads for a particular
entity or group of entities. However, there are benefits and costs to
the use of the midpoint compared to the weighted midpoint for
calculating effective spreads. On the one hand, the midpoint requires
only data on the best available bid and ask price. Calculating the
weighted midpoint on the other hand would require that reporting
entities additionally collect data on the depth available at the
NBBO.\1044\ Furthermore, the midpoint may be easier to compute and
interpret, as it is more familiar to market participants than the
weighted midpoint.
---------------------------------------------------------------------------

    \1044\ Note that this may not be a significant cost, as
reporting entities are required to collect information on NBBO depth
for computing the size improvement benchmark measure under the
proposed amendments. See supra section IV.B.4.(e).
---------------------------------------------------------------------------

(d) Reasonable Alternative Size Improvement Measures
(1) Allow Market Centers To Voluntarily Report ``Real Price
Improvement'' Measures
    The Commission considered alternative measures of size improvement,
including a measure of ``real price improvement'' (``RPI''), which the
petitioner suggested would take into account the depth available at
market quotes.\1045\ RPI is calculated as the signed difference between
the transaction price and a reference price calculated as the value-
weighted average price that the trader would have gotten from walking a
consolidated limit order book consisting of displayed liquidity from
all national securities exchanges, taking into account both odd-lots
and depth available at prices outside of the NBBO. In other words, it
calculates how much money a trader saved by the market center executing
their trade at a particular price, rather than having their order walk
the consolidated limit order book.
---------------------------------------------------------------------------

    \1045\ See supra note 411 and accompanying text.
---------------------------------------------------------------------------

    As the calculation of RPI takes into account the complete set of
information related to the consolidated depth of book, RPI may be a
more informative measure of size improvement than a measure that can be
calculated using the benchmark metric \1046\ proposed to be required by
Rule 605, such as the size enhancement rate,\1047\ which only includes
information about depth at the best displayed prices. However, as the
complete set of consolidated depth of book information is not available
from public data sources, the RPI would require reporting entities to
subscribe to all national securities exchanges' proprietary depth-of-
book data feeds, which would entail a significant cost for those
reporting entities that do not already subscribe to these feeds.\1048\
This could make it so the benefits to market participants from having
access to a potentially more accurate measure of size improvement are
not justified by these additional costs to reporting entities of
needing to subscribe to national securities exchanges' proprietary data
feeds.
---------------------------------------------------------------------------

    \1046\ See supra section IV.B.4.(e) for more information about
this benchmark.
    \1047\ See supra note 884 for information about how the size
enhancement rate is constructed.
    \1048\ In a white paper, one market center estimated its costs
related to subscribing to depth of book data feeds for 11 national
securities exchanges to be between $51,480 and $226,320 per exchange
per year. See The Cost of Exchange Services: Disclosing the Cost of
Offering Market Data and Connectivity as a National Securities
Exchange, IEX (Jan. 2019), available at https://iextrading.com/docs/TThe%20Cost%20Tof%20Exchange%20Services.Tpdf.
---------------------------------------------------------------------------

    In order to compare the extent to which RPI and the size
enhancement rate contain similar information about size improvement,
staff used data from the Tick Size Pilot B.II Market and Marketable
Limit Order dataset \1049\ to calculate the average correlation \1050\
between these two measures. Similar to the analysis in Table 8
examining whether price improvement and size improvement measures
contain different information, staff also calculated the average
correlation between RPI, price improvement and effective spreads, to
confirm that this measure of size improvement contains different
information than the metrics that are already included in Rule 605
reporting requirements. As in Table 8, the analysis is performed
separately for national securities exchanges and off-exchange market
centers.
---------------------------------------------------------------------------

    \1049\ See supra note 882 for dataset description. This analysis
uses data from prior to the implementation of the MDI Rules and the
specific numbers may be different following the implementation of
the MDI Rules. However, it is unclear whether or how these effects
would impact the correlations between these measures documents in
this analysis. See supra note 882 and section VII.C.1.(d)(2).
    \1050\ See supra note 883 for a description of how average
correlations are calculated.
---------------------------------------------------------------------------

    Results are presented in Table 15 and show that RPI and price
improvement are relatively strongly correlated for both national
securities exchanges and off-exchange market centers, implying that
these measures contain some (but not all) of the same information about
execution quality. Similarly, there is moderate correlation between RPI
and effective spreads, implying that these measures are somewhat
overlapping in terms of their information about execution quality for
both types of market centers. This confirms the results from Table 8
that measures of size improvement contain information that is currently
missing from Rule 605 reports. In terms of the extent to which RPI and
the size enhancement rate contain the same information about size
improvement, the Commission found that there is a moderate level of
correlation between RPI and the size enhancement rate (18.4% for
exchanges and 22.7% for off-exchange market centers).

    Table 15--Average Correlation Between Measures of Price and Size
                               Improvement
------------------------------------------------------------------------
                                             National
                                            securities     Off-exchange
              Correlations                   exchanges    market centers
                                             (percent)       (percent)
------------------------------------------------------------------------
RPI and Price Improvement...............            42.1            37.2
RPI and Effective Spreads...............            17.1            25.8
RPI and Size Enhancement Rate...........            18.4            22.7
------------------------------------------------------------------------
Table 15: Average Correlation between Measures of Price and Size
  Improvement. This table presents correlations between three measures
  of price improvement and size improvement: price improvement,
  calculated as the signed difference between the execution price and
  the NBBO, the effective spread, calculated as twice the signed
  difference between the execution price and the NBBO midpoint, and the
  size enhancement rate, calculated as the size improvement share count
  divided by the benchmark share count (see supra note 884 for a
  detailed description of this measure). See supra note 882 for dataset
  description and supra note 883 for methodology. This analysis uses
  data from prior to the implementation of the MDI Rules and specific
  numbers may be different following the implementation of the MDI
  Rules. See supra note 882 and section VII.C.1.(d)(2).

    Given that correlation levels between these two measures are only
moderate, the implication is that RPI does contain information that is
not contained by the proposed benchmark metric. However, even though
RPI may be a more informative measure of size improvement, it is not
clear that the cost of requiring reporting entities to have access to
full set of consolidated depth information would justify the benefit to
market participants of having access to this additional information
about size improvement. If not, the proposed amendment to include the
benchmark consolidated reference quote size, capped at the size of the
order, in Rule 605 reporting requirements would still be a reasonable
proxy for size improvement.
    One alternative might be to add a field to Rule 605 reports for
real PI, but allow reporting entities to voluntarily report this
measure if they subscribe to the full set of proprietary data feeds and
thus have access to the complete set of consolidated depth information.
Note that the requirements would need to specify that only firms that
subscribe to the full set of proprietary data feeds could report this
measure, as an incomplete set of information about availability
liquidity at market prices would systematically overstate any size
improvement measure.
4. Reasonable Alternative Modifications to Accessibility
(a) Require a System for the Centralized Posting of Rule 605 Reports
    Instead of or in addition to having market centers and larger
broker-dealers post Rule 605 reports to their websites, the Commission
could require Rule 605 reports be submitted to a centralized electronic
system, which would then make these reports available to market
participants. Compared to the proposed amendments, requiring the
creation of a centralized electronic system for Rule 605 reports would
promote even greater transparency by better enabling market
participants to access and evaluate the reports of multiple (or even
the complete set of) reporting entities for the purposes of comparison.
Market participants may currently face search costs when collecting
existing Rule 605 reports in order to compare execution quality across
reporting entities, in particular when collecting Rule 605 reports for
multiple entities and across longer time periods.\1051\ A centralized
electronic system for Rule 605 reports would make it easier for market
participants to collect and aggregate data in order to compare
reporting entities as the reports would be available at a single
central location. Compared to the proposed amendments, which maintain
the existing requirement to disseminate Rule 605 reports on a website,
the creation of a centralized electronic system would lower these
search costs. Such search costs would likely increase under the
proposed amendments, which would increase the number of reporting
entities from 236 to 359, including 85 broker-dealers that introduce or
carry 100,000 or more customer accounts.\1052\ The creation of a
centralized electronic system would reduce these search costs by making
it easier for market participants to locate Rule 605 reports, as well
as to collect subsets or even the complete set of Rule 605 reports for
the purpose of comparisons.
---------------------------------------------------------------------------

    \1051\ See supra section VII.C.2.(d) for a discussion of the
current search costs associated with collecting a complete or mostly
complete set of Rule 605 reports to, for example, select the
reporting entity offering the best execution quality in a given
stock. See also supra section VII.D.1.(d)(3) for a discussion of how
these search costs may increase as a result of an increase in the
number of Rule 605 reporting entities under the proposed amendments.
    \1052\ See supra note 486 and accompanying text for a discussion
of the estimated number of reporting entities under the proposed
amendments. See also supra section VII.D.1.(d)(3) for a discussion
of how the increase in reporting entities under the proposed
amendments may increase search costs for some market participants.
---------------------------------------------------------------------------

    The creation of a centralized electronic system would also promote
greater transparency as compared to the proposed amendments by reducing
these search costs and increasing the accessibility of Rule 605 reports
by ensuring that all reports are able to be obtained from a single
location. As a result of this increase in transparency, investors would
be better able to use Rule 605 reports to compare execution quality
across larger broker-dealers, which would increase the extent to which
broker-dealers would need to compete on the basis of execution quality.
Likewise, compared to the proposed amendments, broker-dealers would be
better able to use Rule 605 reports to compare execution quality across
market centers, increasing the extent to which market centers compete
on the basis of execution quality in order to attract order flow.
Requiring a centralized electronic system would also enable
programmatic checks that the Rule 605 reports are appropriately
standardized, formatted, and complete before posting, potentially
reducing processing costs for users. The Commission recognizes that the
entity responsible for administering the Rule 605 centralized
electronic system would incur compliance costs as a result of the
creation and maintenance of such a system (including any programmatic
formatting, completeness, and/or consistency checks on the reports
before posting), which could be passed on to reporting entities in the
form of filing fees and/or to consumers of Rule 605 reports in the form
of access fees. However, to ensure that Rule 605 reports continue to be
freely available, the current requirement for reporting entities to
post a free version of the report on their websites (incorporating any
corrections made pursuant to any aforementioned programmatic
formatting, completeness, and/or consistency checks on the reports)
could be retained along with the additional

requirement for reports to be made available through a centralized
electronic system.\1053\
---------------------------------------------------------------------------

    \1053\ To the extent that potential consumers of Rule 605
reports would not access the reports as a result of a centralized
electronic system's access fees, this would represent a limitation
to the benefits from increased accessibility. If the number of
current consumers of Rule 605 would actually decrease as a result of
these potential access fees, this would represent a cost in the form
of reduced accessibility of Rule 605 reports. However, maintaining
the current requirement for reporting entities to post a free
version of the report on their websites would obviate this cost.
---------------------------------------------------------------------------

    Furthermore, to the extent that the centralized electronic system
would include programmatic formatting, completeness, and/or consistency
checks on Rule 605 reports before accepting them, reporting entities
would also incur costs to resolve any issues detected by such checks.
Reporting entities would be most efficiently situated to remedy any
identified issues in their own reports before they are posted.
    The Commission has specifically considered two options for how to
implement the centralized electronic system: using the existing Rule
605 NMS Plan and the Commission's Electronic Data Gathering, Analysis,
and Retrieval (``EDGAR'') system. Table 16 summarizes the costs and
benefits of each of these alternatives, which are also discussed in
more detail in the sections below. The Commission acknowledges there
may be other options for a centralized system and requests comment on
these other options.

   Table 16--Summary of Costs and Benefits of Alternative Centralized
                           Electronic Systems
------------------------------------------------------------------------
  Mechanism for centralized
     posting of reports               EDGAR               NMS plan
------------------------------------------------------------------------
                Benefits Relative to Proposed Amendments
------------------------------------------------------------------------
Accessibility...............  Reports would be in   Reports would be in
                               one place, reducing   one place, reducing
                               search costs and      search costs and
                               increasing the        increasing the
                               benefits of Rule      benefits of Rule
                               605 reporting.        605 reporting. The
                               EDGAR could include   NMS Plan could
                               programmatic checks   include
                               to ensure the         programmatic checks
                               reports are           to ensure the
                               appropriately         reports are
                               standardized,         appropriately
                               formatted, and        standardized,
                               complete before       formatted, and
                               posting,              complete before
                               potentially           posting,
                               reducing processing   potentially
                               costs for users.      reducing processing
                               EDGAR functionality   costs for users.
                               would allow           However, the
                               consumers to search   specific
                               for specific          functionality and
                               reports or all        ease of access is
                               reports for a given   uncertain. Any
                               month. However,       access fees could
                               consumers wishing     limit benefits.
                               to combine reports
                               for analysis would
                               need to pull each
                               report separately.
                               EDGAR does not
                               charge access fees.
------------------------------------------------------------------------
                  Costs Relative to Proposed Amendments
------------------------------------------------------------------------
Costs to Build..............  n/a.................  Plan participants
                                                     would incur costs
                                                     to build a system
                                                     to collect and
                                                     validate or to
                                                     contract with
                                                     someone who already
                                                     has a system that
                                                     could work.
Costs to Maintain...........  n/a.................  Plan participants
                                                     would incur the
                                                     cost of maintaining
                                                     a reporting system.
Reporting Costs.............  Reporting entities    Reporting entities
                               that do not already   could pay a
                               submit documents to   reporting fee to
                               the Commission via    cover the costs of
                               EDGAR would incur a   the Plan
                               one-time burden to    participants.
                               obtain EDGAR access   Reporting entities
                               codes. Reporting      would incur costs
                               entities would        if their reports
                               incur costs if        contain formatting,
                               their reports         completeness, or
                               contain formatting,   consistency issues
                               completeness, or      that would require
                               consistency issues    resolution before
                               that would require    acceptance.
                               resolution before
                               acceptance. EDGAR
                               does not charge
                               filing fees.
Coordination Costs..........  n/a.................  Plan participants
                                                     would incur costs
                                                     to coordinate on
                                                     amending the NMS
                                                     Plan.
------------------------------------------------------------------------
Table 16: Summary of Costs and Benefits of Alternative Centralized
  Electronic Systems. This table presents a qualitative summary of the
  benefits and costs that the Commission estimates would result from
  various alternatives requiring the centralized posting of Rule 605
  reports, relative to the proposed amendments. These benefits and costs
  are discussed in more detail in infra sections VII.E.4.(a)(1)-(2).

(1) Require Rule 605 Reports To Be Provided Through the NMS Plan
    One alternative would be to require that procedures established
pursuant to the NMS Plan provide for the creation and maintenance of a
centralized electronic system to serve as a repository for Rule 605
reports. In this alternative, the proposed rule text could specify that
the NMS plan procedures shall provide for the creation and maintenance
of a centralized electronic system for such reports and make such
reports available for viewing and downloading in a manner that is free
and readily accessible to the public. However, the rule text could
retain existing language such that, in the event there is no plan or
system currently establishing such procedures, reports shall be
prepared in a consistent, usable, and machine-readable electronic
format and be made available for downloading from an internet website
that is free and readily accessible to the public.\1054\ In other
words, in the absence of procedures providing for the creation and
maintenance of a centralized electronic system, Rule 605 reports are
required to be made available for download from an internet website
that is free and readily accessible to the public (or as specified by
the then-current NMS plan). This backstop requirement will help to
assure the continued availability of execution quality information
while a centralized electronic system is developed.
---------------------------------------------------------------------------

    \1054\ See 17 CFR 242.605(a)(2).
---------------------------------------------------------------------------

    As discussed above, the creation of a centralized electronic system
would generally result in additional economic benefits as compared to
the proposed amendments by further promoting transparency and
competition, and by reducing market participants' search costs by
ensuring that all Rule 605 reports could be obtained from a single

location. However, as the NMS Plan would be tasked with designing and
implementing the centralized electronic system, the Commission would ex
ante be uncertain as to the specific functionality and ease of access
that such a centralized electronic system would provide. Any
differences between this alternative and any other alternative in terms
of the accessibility and timeliness of centralized Rule 605 information
would depend on how the NMS Plan would develop the functionality for
distributing or making the Rule 605 reports public.
    The Commission estimates that the NMS Plan participants, consisting
of 16 national securities exchanges and 1 national securities
association, would incur initial and ongoing compliance costs
associated with this alternative. First, the NMS Plan participants
would incur initial compliance costs associated with preparing and
filing amendments to the NMS Plan to account for the creation of a
centralized electronic system to make reports available for viewing and
downloading, along with the implementation and enforcement of that
system. The Commission estimates that there would be a one-time (or
initial) burden of 65 hours per NMS Plan participant to account for the
creation of a centralized electronic system.\1055\ Furthermore, the
Commission estimates that the NMS Plan participants would incur an
ongoing, annual burden of 15 hours per NMS Plan participant \1056\
associated with the maintenance of the centralized electronic system.
NMS Plan participants would likely also incur coordination costs to
reach an agreement on the design and implementation of a centralized