Market......................            0.23            49.4             0.5            11.3            61.3
    Limit.......................          0.0003            37.8             0.4             0.5            38.7
Individual:
    Market......................            6.44            68.3             9.0            10.3            87.6
    Limit.......................            0.03            10.1             1.7             0.6            12.4
----------------------------------------------------------------------------------------------------------------
Table 4: Stop Order Volume by Account and Order Types, March 2022. This table shows the percentage of orders
  that are submitted with stop prices (as a percentage of total orders) separately for accounts associated with
  institutional and individual investor types and for market and limit orders, using a sample of CAT data for
  all NMS stocks from March 2022. Also shown is a breakdown of stop order submission volume according to six
  common types of stop orders. See supra note 657 for information on the dataset and identification of stop
  orders.

(3) Non-Exempt Short Sale Orders
    Commission staff has taken the position that staff would view all
non-exempt short sale orders as special handling orders.\658\ As a
result, these orders are currently not included as part of Rule 605
statistics, which may exclude a large portion of orders that are likely
relevant for market participants.
---------------------------------------------------------------------------

    \658\ See 2013 FAQs.
---------------------------------------------------------------------------

    Non-exempt short sale orders are orders that are subject to price
restrictions under Rule 201 of Regulation SHO,\659\ which contains a
short sale circuit breaker that, when triggered by a price decline of
10% or more from a covered security's prior closing price, imposes a
restriction on the price at which the covered security may be sold
short (i.e., must be above the current national best bid). Once
triggered, the price restriction will apply to short sale orders in
that security for the remainder of the day and the following day,
unless the short sale order is ``short exempt.'' \660\ Since a non-
exempt short sale that is subject to a price restriction is only
allowed to take place at least one tick above the NBB, these could be
``orders to be executed on a particular type of tick or bid,'' which
would exclude them from the definition of ``covered orders.'' \661\ The
exclusion of tick-sensitive orders from Rule 605 reporting requirements
ensures that these orders do not skew execution quality statistics, as
the prevention of

these orders from executing at the best bid would likely lead to lower
execution quality statistics (e.g., negative price improvement and
higher effective spreads) as compared to other orders.
---------------------------------------------------------------------------

    \659\ See supra note 246 for more information about Rule 201 of
Regulation SHO.
    \660\ ``Short exempt'' orders include short sale orders from
market makers and short sales priced above the current national best
bid at the time of submission. See 17 CFR 242.201(c) and (d).
    \661\ See supra section II.B.1.(b) for a discussion of the
definition of covered orders.
---------------------------------------------------------------------------

    However, in the years since Rule 201's adoption, it has become
clear that Rule 201 price test restrictions are not often triggered.
Staff found that, between April 2015 and March 2022, a Rule 201 trigger
event only occurred on 1.7% of trading days for an average stock.\662\
Around 18% of Rule 201 triggers occur the day after a previous trigger
event, and around 46% occur within a week after a previous trigger
event. These statistics imply that Rule 201 triggers tend to be
relatively rare, and clustered around a few isolated events.
---------------------------------------------------------------------------

    \662\ This analysis looked at the percentage of trading days
that experienced a Rule 201 trigger event for the period January
2012 to February 2021 for all listed stocks on NYSE or NASDAQ
exchanges and then averaged across stocks. The Commission restricted
its sample to common stocks identified in CRSP (share code 10 or
11), from CRSP 1925 US Stock Database, Ctr. Rsch. Sec. Prices, U.
Chi. Booth Sch. Bus. (2022). The Commission also excluded financial
stocks (SIC code 6000-6999), as financial stocks may have different
properties than other types of stocks, including characteristics
related to short selling (e.g., Markus K. Brunnermeier & Martin
Oehmke, Predatory Short Selling, 18 Rev. Fin. 2153 (2014)). Rule 201
circuit breaker data retrieved from ftp://ftp.nyxdata.com/NYSEGroupSSRCircuitBreakers/ and ftp://ftp.nasdaqtrader.com/SymbolDirectory/shorthalts/.
---------------------------------------------------------------------------

(4) Orders Submitted Pre-Opening/Post-Closing
    When Rule 605 was first adopted, the Commission explained the
decision to exclude orders submitted outside of regular trading hours
by stating that there are substantial differences in the nature of the
market between regular trading hours and after-hours, and therefore
orders executed at these times should not be blended together.\663\
However, the current exclusion of all orders submitted outside of
regular market hours from the definition of ``covered order,'' \664\ in
addition to excluding orders that execute outside of regular hours,
also extends to orders that, while submitted outside of regular market
hours, are only eligible to execute during regular market hours. While
these orders represent only a small portion of order flow, they
represent a relatively high concentration of orders from individual
investors. Therefore, the current exclusion of all orders submitted
outside of regular trading hours from Rule 605 may lead to the
exclusion of an important segment of individual investor orders.
---------------------------------------------------------------------------

    \663\ See Adopting Release, 65 FR at 75421.
    \664\ See 17 CFR 242.600(b)(77).
---------------------------------------------------------------------------

    When Rule 605 was first adopted, after-hours markets were still
mostly the purview of institutional investors, but a growing number of
broker-dealers had recently begun providing their retail customers with
the ability to have their orders directed to electronic communication
networks (ECNs) after the major markets close for the day. The growth
in the availability of after-hours trading for individual investors
raised concerns over, and heightened awareness of, the differences in
execution quality for after-hours trades, which tend to be much riskier
due to lower liquidity levels and higher volatility in after-hours
markets.\665\
---------------------------------------------------------------------------

    \665\ See, e.g., Special Study: Electronic Communication
Networks and After-Hours Trading, SEC (June 2000), available at
https://www.sec.gov/news/studies/ecnafter.htm.
---------------------------------------------------------------------------

    Along with an increase in access to after-hours trading, the late
1990s and early 2000s saw an increase in the prevalence of online
brokerages, in which individual investors in particular were given
newfound access to order entry systems. Early research into the rise of
online brokerages describes a shift from a system in which retail
brokers ``communicate buy/sell recommendations to clients over the
telephone'' (presumably during regular working hours), to a system in
which individual investors have ``round-the-clock access to trading
systems and account information.'' \666\ Logically, as investors make
use of the ``round-the-clock'' access offered by online brokerages, the
number of orders submitted outside of regular market hours has likely
increased over the preceding decades. However, not all orders submitted
after hours are eligible to trade in after-hours markets, which
continues to be the case even in today's market. For example, some
broker-dealers' platforms allow customers to submit orders at any time,
but unless the customer requests to trade during extended hours and the
security is eligible to trade as such, the order will only be executed
during regular market hours.\667\ Since these orders are not intended
to, and in many cases are not eligible to, execute outside of regular
trading hours, these orders may not be subject to the same concerns
that drove the Commission to exclude orders submitted outside of
trading hours from Rule 605 reporting requirements in the Adopting
Release.
---------------------------------------------------------------------------

    \666\ Jennifer Wu, Michael Siegel & Joshua Manion, Online
Trading: An Internet Revolution, Sloan School of Management
Massachusetts Institute of Technology Research Notes, p. 4 (1999).
    \667\ See, e.g., Extended Hours Overview, Charles Schwab,
available at https://www.schwab.com/public/schwab/nn/qq/about_extended_hours_trading.html; Extended-Hours Trading,
Robinhood, available at https://robinhood.com/us/en/support/articles/extendedhours-trading/.
---------------------------------------------------------------------------

    To estimate the amount of orders that are submitted outside of
regular trading hours, data from the Tick Size Pilot B.I Market Quality
dataset \668\ was analyzed to break order volume down into different
trading sessions according to when the order was eligible to
trade.\669\ The Commission considers only those orders that have an
effective time during regular market hours to be eligible for Rule 605
reporting, and excludes orders that are otherwise excluded from current
Rule 605 reporting requirements, i.e., because they are an excluded
order type or size. The Commission found that a small fraction of
orders are effective outside of regular market hours (1.3%), while the
vast majority of orders (98.7%) are effective during regular market
hours.
---------------------------------------------------------------------------

    \668\ See supra note 619 for dataset description.
    \669\ These trading sessions include (1) regular hours only; (2)
extended hours only; (3) both regular and extended hours with an
effective time during regular market hours; and (4) both regular and
extended hours with an order effective time during extended hours.
See Tick Size Pilot Program Appendix B and C Frequently Asked
Questions, Q4.11, available at https://www.finra.org/sites/default/files/Tick-Size-Pilot-Appendix-B-and-C-FAQ.pdf.
---------------------------------------------------------------------------

    At least some of these orders, while submitted outside of regular
market hours, execute during regular trading hours, e.g., because they
are NMLOs that are only eligible to execute during regular trading
hours.\670\ In order to estimate the extent to which this occurs, a
sample of CAT data \671\ was analyzed to examine submission volumes of
NMLOs submitted outside of regular trading hours that were designated
as only eligible to trade during regular trading hours,\672\ and
compared them to

the volumes and characteristics of NMLOs submitted during a sample 10-
minute time window from 9:40 a.m. to 10:40 a.m. This analysis confirms
that pre-open orders eligible to trade during regular trading hours
likely 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. However, further
analysis reveals that these orders contain a high concentration of
individual investor orders. Specifically, pre-open share volume
contains a much larger fraction of individual investor shares (29.5%)
than the sample time window during regular trading hours (1.9%), at
least for off-exchange market centers for which individual investor
orders could be identified.\673\ This is consistent with the idea that
at least some of this order flow represents orders that are submitted
by individual investors outside of market hours, i.e., via online
brokerage accounts, but not necessarily with the intention to engage in
after-hours trading.
---------------------------------------------------------------------------

    \670\ Note that most retail brokers do not permit market orders
during extended hours trading. See, e.g., Extended Hours Overview,
Charles Schwab, available at https://www.schwab.com/public/schwab/nn/qq/about_extended_hours_trading.html; Extended-Hours Trading,
Robinhood, available at https://robinhood.com/us/en/support/articles/extendedhours-trading/.
    \671\ The sample consists of 390 stocks for the period of March
2021. Note that this sample of NMLOs collected from CAT may include
NMLOs that would not be included in Rule 605 reports, if they never
touch the NBBO at any point during their lifespan. Characteristics
include whether the order was submitted to an exchange or off-
exchange market center, distance from the prevailing quote midpoint
(or, in the case of pre-open orders, from the open price) in basis
points (bps), and order size in terms of number of shares. For off-
exchange orders, the Commission is also able to characterize whether
the order was initially submitted by an individual investor.
    \672\ The definition of marketability for the purposes of this
analysis for pre-open orders is determined using the NBBO that is
first disseminated after the time of order receipt, such that orders
to be executed at a market opening price are excluded. See supra
note 231 and accompanying text for more information about defining
the marketability of orders submitted outside of regular market
hours.
    \673\ As the account type (i.e., individual or institutional)
data field is only available upon order origination and is not
transferred to the executing market center, staff was not able to
differentiate individual investors in the CAT data for exchanges.
---------------------------------------------------------------------------

(c) Information Required by Current Rule 605 Reporting Requirements
    In addition to decreasing the coverage of Rule 605, subsequent
market changes since the initial adoption of Rule 605 may have also
decreased the relevance of some of the metrics included in Rule 605
reports. This section will discuss how market changes may have
affected, or will likely affect in the near future, aspects of several
such metrics, including the definition of round lots for order size
categories, the granularity of metrics related to time-to-execution,
and the use of a five-minute time horizon for realized spreads.
(1) Order Size Categories
    The Commission believes that defining order size categories in
terms of numbers of shares has led these order size categories to be
less informative about differences in execution qualities across
differently-sized orders. To illustrate, consider that some Regulation
NMS rules exclude orders or trades that are sized above $200,000, as
these orders typically warrant different treatment than smaller
orders.\674\ For a $50 stock, a $200,000 order would be equivalent to
around 4,000 shares, meaning that typically-sized orders (i.e., orders
that are not excluded from the previously described Regulation NMS
rules) below $200,000 (and above $500, given that orders below 100
shares are excluded) are split between three order size categories: 100
to 499 shares, from 500 to 1999 shares, and from 2000 to 4999 shares.
Market participants are therefore able to use these order size
categories to compare across orders of different sizes. However, for a
$500 stock, a $200,000 order would only be equivalent to 400 shares.
Therefore, for the purposes of Rule 605 reporting, nearly all
typically-sized orders in this high-priced stock are either grouped in
the smallest order size category (100 to 499 shares \675\), or, if they
would fall below the smallest order size category of 100 shares,
excluded altogether from reporting requirements.\676\ As all orders
tend to be clustered into a single category, market participants are
unable to use these categories to compare across orders of different
sizes in higher-priced stocks. Similarly, at least one market
participant argues that the definition of the current order size
categories in terms of number of shares together with the exclusion of
orders of less than 100 shares,\677\ has led to the exclusion of more
orders with low dollar values as the average stock price
increases.\678\
---------------------------------------------------------------------------

    \674\ See, e.g., Rule 606(a)(1) of Regulation NMS (requiring
reports on the routing of customer orders) and Rule 600(b)(25) of
Regulation NMS (defining ``customer order'' to exclude an order with
a market value of $200,000 or more); Rule 604(b)(4) of Regulation
NMS (providing an exception for orders of block size from required
limit order display) and Rule 600(b)(12) of Regulation NMS (defining
``block size'' as, in part, an order for a quantity of stock having
a market value of at least $200,000).
    \675\ See 17 CFR 242.605(a)(1). See also supra note 40 and
corresponding text for a definition of the current order size
categories included in Rule 605 reporting requirements.
    \676\ In addition, even prior to the implementation of the MDI
Rules, a small number of NMS stocks have a round lot size smaller
than 100. See supra note 266.
    \677\ See supra section VII.C.2.(b)(1)(a) for a discussion of
the exclusion of orders that are less than 100 shares from current
Rule 605 reporting requirements.
    \678\ See Phil Mackintosh, Modern Retail Needs Modern Rules,
NASDAQ (May 27, 2021, 11:54 a.m.), available at https://www.nasdaq.com/articles/modern-retail-needs-modern-rules-2021-05-27/.
---------------------------------------------------------------------------

    Furthermore, the Commission's 2020 adoption of the MDI Rules
included a new definition of ``round lot'' that causes some round lots
to be excluded from reporting requirements, absent an update to Rule
605's order size categories.\679\ Specifically, the current size
categories as defined under Rule 605, which exclude orders with fewer
than 100 shares, exclude a portion of round lots for stocks with prices
greater than $250.
---------------------------------------------------------------------------

    \679\ See supra note 577 for a definition of these tiers.
---------------------------------------------------------------------------

(2) Non-Marketable Limit Order Categories
    The Commission preliminarily believes that the current
categorization of NMLOs may include orders whose executions are more
likely to depend on their limit prices and price movements in the
market, and exclude orders whose executions are more likely to depend
on their handling by the market center. This could lead to the
excessive exclusion of limit orders whose execution quality may be
relevant to both individual and institutional investors.\680\
---------------------------------------------------------------------------

    \680\ Both institutional and individual investors likely make
use of NMLOs. One academic study, using data on retail orders
between 2003 and 2007 from two OTC market centers, estimated that
NMLOs made up around 39% of individual investor order flow. See Eric
K. Kelley & Paul C. Tetlock, How Wise are Crowds? Insights from
Retail Orders and Stock Returns, 68 J. Fin. 1229 (2013). Other
academic papers suggest that NMLO usage by institutional investors
may also be high. See, e.g., Amber Anand, Sugato Chakravarty &
Terrence Martell, Empirical Evidence on the Evolution of Liquidity:
Choice of Market Versus Limit Orders by Informed and Uninformed
Traders, 8 J. Fin. Mkt. 288 (2005); Ron Kaniel & Hong Liu, So what
orders do informed traders use?, 79 J. Bus. 1867 (2006).
---------------------------------------------------------------------------

    When proposing to exclude away-from-the-quote NMLOs with a limit
price more than ten cents away from the NBBO, the Commission reasoned
that the execution quality statistics for these types of orders may be
less meaningful because their executions depend more on the order's
limit price and price movement in the market than on handling by the
market center.\681\ Meanwhile, the current ``near-the-quote'' limit
order category \682\ is meant to include limit orders that are
submitted away from the NBBO, but that still have a relative likelihood
of being executed (hence the minimum distance requirement from the
NBBO). However, it is important to note that the likelihood of
execution of both greatly depends on the movement of the NBBO. An order
submitted even within 10 cents of the NBBO may never receive an
opportunity to be executed if that order never touches the NBBO (e.g.,
if prices were to move away from that order immediately after
submission), and an order that is submitted further than 10 cents may
indeed eventually execute if prices move towards the order.
---------------------------------------------------------------------------

    \681\ See Proposing Release, 65 FR 48406 (Aug. 8, 2000) at
48414.
    \682\ See 17 CFR 242.600(b)(14).
---------------------------------------------------------------------------

    Figure 7 breaks down a sample of MIDAS NMLO submission data from 80
stocks in March 2022 \683\ into NMLO

types, including away-from-the-quote, near-the-quote, and at-the-quote
NMLOs, along with several categories of inside-the-quote NMLOs
depending on their distance from the midpoint (below-the-midpoint, at-
the-midpoint, and beyond-the-midpoint).\684\ The figure shows that
away-from-the-quote NMLOs represent nearly a quarter of all non-
marketable share volume.
---------------------------------------------------------------------------

    \683\ See supra note 634 for a description of the dataset.
    \684\ Results may be different following the implementation of
the MDI Rules. Specifically, the NBBO is anticipated to narrow for
stocks priced above $250 as a result of the new definition of round
lots, which would likely decrease the number of inside-the-quote
NMLOs and increase the number of quotes at or outside of the quotes
for these stocks. See supra section VII.C.1.(d)(2) for further
discussion.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P

Figure 7: Order Submission Share Volume by NMLO Type, March 2022
[GRAPHIC] [TIFF OMITTED] TP20JA23.007

    Figure 8 presents data on the fill rates of NMLO orders, broken
down by NMLO type, using the same sample of MIDAS NMLO submission
data.\685\ The figure shows that near-the-quote and away-from-the-quote
NMLOs appear very similar in terms of fill rates (0.6% and 0.18%,
respectively), particularly compared to other types of NMLOs (e.g.,
inside-the-quote NMLOs have an average fill rate of around 2.7% to
5.1%). The fact that near-the-quote and away-from-the-quote NMLOs have
similar fill rates is consistent with the possibility that the current
exclusion of NMLOs priced more than 10 cents away from the NBBO is
based on a threshold that does not optimally differentiate between
orders that have a meaningful chance to execute.\686\ Meanwhile, orders
that never have a meaningful opportunity to execute (e.g., because they
never touch the NBBO) may be included in Rule 605 statistics. To get an
idea of the extent to which such orders are currently included in Rule
605 statistics, note that, according to Figure 8, more than 99% of
near-the-quote NMLOs do not execute, which, according to Figure 7,
represents around 36% of total submission volume. While it is possible
that some of these orders did not execute because of their handling by
the market center, it is unlikely that this is case for all of them,
and likely that some of the lack of fills was the result of other
factors, such as price movements or cancellations by the
submitter.\687\
---------------------------------------------------------------------------

    \685\ The distribution of orders into various NMLO categories
may change following the implementation of the MDI Rules. See supra
note 684 and section VII.C.1.d)(2). However, it is not clear how a
change in the distribution of orders into various NMLO categories
would affect the average fill rates of these NMLO categories.
    \686\ Commenters supported including NMLOs further away from the
quote in Rule 605 reports but noted the difficulty of providing
meaningful execution quality statistics for such orders. See supra
notes 296-297 and accompanying text.
    \687\ See infra section VII.E.2.(b) for a discussion of how NMLO
orders that are cancelled quickly after submission may impact fill
rates.
---------------------------------------------------------------------------

Figure 8: Fill Rates of NMLOs, March 2022

[GRAPHIC] [TIFF OMITTED] TP20JA23.008

    Furthermore, defining the threshold for inclusion in Rule 605
reporting requirements in nominal terms (i.e., 10 cents) means that
NMLO coverage varies depending on the stock price: high-price stocks
with smaller relative tick sizes have less NMLO coverage, since 10
cents represents a relatively tighter band around the NBBO.\688\ This
is shown in Figure 9, which breaks down the NMLO submission volumes in
Figure 8 by both order type and average share prices. The figure shows
that away-from-the-quote NMLOs represent 24.4% of total NMLO share
volumes for the group of stocks with the highest share prices, but only
8.4% for the group of stocks with the lowest share prices. Excluding
large portions of relevant NMLOs results in less reliable market
quality measures; this may especially be the case for high-priced
stocks, thus making comparisons between market centers less reliable
for these stocks.
---------------------------------------------------------------------------

    \688\ Results may be different following the implementation of
the MDI Rules. Specifically, NMLO coverage for stocks priced above
$250 may decrease even further, as the narrowing of the NBBO for
these stocks would result in even tighter price bands. See supra
section VII.C.1.(d)(2) for further discussion.
---------------------------------------------------------------------------

Figure 9: Order Submission Share Volume by NMLO Type and Stock Price
Quartiles, March 2022

[GRAPHIC] [TIFF OMITTED] TP20JA23.009

(3) Beyond-the-Midpoint Limit Orders
    Currently, Rule 605 reports may not accurately reflect how the
execution quality of inside-the-quote NMLOs may vary across market
centers. The Commission preliminarily understands that some inside-the-
quote limit orders may have different execution quality characteristics
than other types of NMLOs, and that this may vary across market
centers. In particular, the Commission preliminarily understands that
some market centers, such as some wholesalers, treat ``beyond-the-
midpoint'' limit orders (i.e., NMLOs that are priced more aggressively
than the midpoint) like marketable limit orders and will offer price
improvement to these orders. However, because they are not a marketable
order type (i.e., they do not fully cross the spread), some statistics
are not currently calculated for inside-the-quote limit orders,
including price improvement statistics and effective spreads.
    In order to examine this possibility, Table 5 presents results from
an analysis of the execution quality of beyond-the-midpoint NMLOs
compared to other order types, including market, marketable limit, and
other types of inside-the-quote NMLOs, using a sample of orders
executed by the six most active wholesalers from CAT data for the
period of Q1 2022.\689\ The results show that beyond-the-midpoint NMLOs
executed by wholesalers tend to have much faster time-executions and
higher fill rates than other types of inside-the-quote NMLOs, and are
also somewhat more likely to be given price improvement. Grouping
beyond-the-midpoint orders together with other NMLOs obscures the
differences in these market centers' treatment of these types of
orders, including potential differences in price improvement.
---------------------------------------------------------------------------

    \689\ See supra note 609 for dataset description. This dataset
is from prior to the implementation of the MDI Rules and the
distribution of orders into various NMLO categories, including
beyond-the-midpoint orders, may change following the implementation
of the MDI Rules. See supra note 684 and section VII.C.1.(d)(2).
However, it is not clear how a change in the distribution of orders
into various NMLO categories would affect the average fill rates and
time-to-execution of these NMLO categories. The percent of price-
improved orders may also change, depending on how wholesalers adjust
their price improvement practices in stocks with narrower spreads.
However, it is unclear how the percentage of price-improved beyond-
the-midpoint NMLOs would change relative to other types of NMLOs.

    Table 5--Execution Quality Characteristics of Beyond-the-Midpoint NMLOs Executed by Wholesalers, Q1 2022
----------------------------------------------------------------------------------------------------------------
                                                   Average time-  Median time-to-                 Price-improved
                   Order type                      to-execution      execution    Fill rates (%)     orders (%
                                                     (seconds)       (seconds)                    total  orders)
----------------------------------------------------------------------------------------------------------------
Market..........................................           21.19            0.04            91.0            78.1
Marketable Limit................................          233.95            3.22            94.0            55.9
Beyond-the-Midpoint NMLOs.......................         1503.31          145.49            94.1             4.6

At-the-Midpoint and Below-the-Midpoint NMLOs....         4189.13         1480.60            81.7             1.1
----------------------------------------------------------------------------------------------------------------
Table 5: Execution Quality Characteristics of Beyond-the-Midpoint NMLOs Executed by Wholesalers, Q1 2022. This
  table shows execution quality metrics for different order types handled by the top six wholesalers using CAT
  data during the period of Q1 2022. See supra note 609 for dataset description. This analysis uses data from
  prior to the implementation of the MDI Rules and results may be different following the implementation of the
  MDI Rules. See supra note 689 and section VII.C.1.d)(2).

(4) Time-to-Execution
    The rapid increase in execution speeds in modern markets has
decreased the usefulness of time-to-execution information that is
currently required in Rule 605 reports.\690\ Currently, time-to-
execution information is required in Rule 605 reports in two ways:
first, for market and marketable limit orders, the share-weighted
average time-to-executions for orders executed with price improvement,
at the quote, and with price dis-improvement, calculated based on
timestamps recorded in seconds; and second, for all orders, the number
of shares executed within certain pre-defined time-to-executions
categories.\691\
---------------------------------------------------------------------------

    \690\ See supra note 133 and accompanying text discussing
concerns raised by commenters about the current provisions in Rule
605 for time-to-execution information.
    \691\ See supra note 343 for a definition of these time-to-
execution categories.
---------------------------------------------------------------------------

    First, calculating average time-to-execution statistics using
timestamps recorded in terms of seconds does not reflect changes in
market speeds. Figure 10 uses data from the SEC's MIDAS analytics tool
\692\ to plot the percentage of on-exchange NMLOs that, conditional on
being executed,\693\ are fully executed within one second or less from
the time of submission between Q4 2012 and Q1 2022. The figure shows
that this percentage has increased over time across different market
capitalization groups, and that in Q1 2022 more than half (51.6%) of
executed NMLOs are executed in less than one second in large market cap
stocks. Therefore, while timestamps expressed in seconds may have been
appropriate for the markets when Rule 605 was first adopted, they are
likely to miss much of the variation in time-to-execution across market
centers in today's markets.
---------------------------------------------------------------------------

    \692\ See dataset Conditional Cancel and Trade Distributions,
SEC, available at https://www.sec.gov/marketstructure/downloads.html. If the order is not fully executed, it is treated as
canceled at the close. See Quote Life Report Methodology, SEC,
available at https://www.sec.gov/marketstructure/quote-life-report-methodology.
    \693\ I.e., Figure 10 plots the number of fully executed NMLOs
executed within one second relative to the total number of fully
executed on-exchange NMLOs. Note that, in contrast, Figure 8 plots
the number of executed NMLO shares divided by the total number of
submitted NMLO shares.
---------------------------------------------------------------------------

Figure 10: Percentage of NMLOs Executed Within One Second, Q1 2012-Q4
2022
[GRAPHIC] [TIFF OMITTED] TP20JA23.010

    Second, given that many orders are executed on a sub-second basis,
the current time-to-execution buckets prescribed by Rule 605 are not
able to fully capture variations in time-to-executions across order
types.\694\ To illustrate this, Figure 11 groups on-exchange NMLO
executions collected from MIDAS for the period of March 2022 \695\ into
time-to-execution buckets that correspond to those currently defined in
Rule 605. The figure shows that, while the distribution of orders looks
reasonable for away-from-the-quote and near-the-quote NMLOs, for which
executions are relatively evenly distributed across the time-to-
execution categories, these categories do not capture much
differentiation for other NMLO types, particularly for those that take
place inside the quote. For inside-the-quote NMLOs, 84.2% to 85.7% of
orders are grouped in the shortest time-to-execution bucket (from 0 to
less than 10 seconds), depending on the distance to the midpoint, while
the category corresponding to the longest time-to-execution bucket
defined by Rule 605 (5 to 30 minutes) has only 1.1% to 1.3% of
executions. Therefore, these time-to-execution categories likely do not
fully capture variations in the execution times of these orders across
reporting entities.
---------------------------------------------------------------------------

    \694\ See supra note 343 for a definition of these time-to-
execution categories.
    \695\ See supra note 634 for data description. Note that this
dataset includes only NMLOs submitted to exchanges that do not
immediately execute and are subsequently posted to the limit order
book. The results of this analysis may not reflect the execution
quality of inside-the-quote NMLOs that execute immediately, e.g.,
against hidden liquidity on the limit order book. Furthermore, this
dataset is from prior to the implementation of the MDI Rules and the
distribution of orders into various NMLO categories may change
following the implementation of the MDI Rules. See supra note 684
and section VII.C.1.(d)(2). However, it is not clear how a change in
the distribution of orders into various NMLO categories would affect
the average time-to-execution of these NMLO categories.
---------------------------------------------------------------------------

Figure 11: Distribution of NMLO Execution Times, March 2022
[GRAPHIC] [TIFF OMITTED] TP20JA23.011

    MIDAS data includes only orders and quotes that are posted on
national securities exchanges' LOBs and trades that are executed
against those orders,\696\ and as such it is not possible to view the
submission times (and thus calculate the time-to-execution of) market
and marketable limit orders using MIDAS data. As a result, the above
analysis is only able to consider the time-to-execution of on-exchange
NMLOs. In order to estimate the time-to-execution of both on- and off-
exchange orders, including market and marketable limit orders, the
Commission used the Tick Size Pilot B.I Market Quality data from April
2016 until March 2019.\697\
---------------------------------------------------------------------------

    \696\ See supra note 634. MIDAS data includes information about
off-exchange trade executions, but not information about any off-
exchange order submissions, so it is also not possible to use MIDAS
data to calculate the time-to-execution of off-exchange orders.
    \697\ See supra note 619 for data description. Note that, as the
Tick Size Pilot only collected data for small cap stocks, these
execution times are not necessarily representative of all stocks.
For example, larger market cap stocks are typically more liquid and
likely execute faster. Also, as this is an older data set (April
2016 until March 2019), it may be that market speeds have changed
since this time. However, as it is likely that market speeds have
only gotten faster since this time period, it could represent a
lower bound on execution times and therefore still give an idea of
how relevant the current Rule 605 time-to-execution buckets are for
market and marketable limit orders. Lastly, this dataset also
includes off-exchange orders, while the MIDAS data only includes on-
exchange orders, which could result in different execution times
between the two datasets. Furthermore, this dataset is from prior to
the implementation of the MDI Rules and the distribution of orders
into various NMLO categories may change following the implementation
of the MDI Rules. See supra note 684 and section VII.C.1.(d)(2).
However, it is not clear how a change in the distribution of orders
into various NMLO categories would affect the average time-to-
execution of these NMLO categories.

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

Figure 12 shows the distribution of time-to-execution statistics for
market and marketable limit orders, along with the three categories of
non-marketable limit orders currently required in Rule 605 reports
(i.e., inside-the-quote, at-the-quote, and near-the-quote). Note that
the time-to-execution categories defined in the Tick Size Pilot dataset
are more granular than those in Rule 605.

Figure 12: Distribution of Order Execution Times, April 2016-March 2019
[GRAPHIC] [TIFF OMITTED] TP20JA23.012

    Echoing the results using MIDAS data in Figure 11, Figure 12 shows
that, for at-the-quote and near-the-quote limit orders, executions are
reasonably well distributed across the different time-to-execution
buckets and there is positive volume in the longer time-to-execution
buckets that are included in both the Rule 605 and Tick Size Pilot
categorizations (30 to 59 seconds, 60 to 299 seconds, and 5 to 30
minutes). However, similar to the results for inside-the-quote NMLOs,
for market and marketable limit orders, execution times are mostly
bunched up at the faster end of their time buckets; in fact, the vast
majority of these orders are executed in under one second, falling
within the shortest Rule 605 category of shares executed from 0 to 9
seconds. Likewise, the longer time-to-execution buckets that are
included in both the Rule 605 and Tick Size Pilot categorizations are
virtually empty. Therefore, as with inside-the-quote NMLOs, current
Rule 605 time-to-execution categories are missing information about
potential differences across reporting entities in terms of the
execution times of the market and marketable limit orders that they
handle, which limits the usefulness of time-to-execution information
for investors.\698\
---------------------------------------------------------------------------

    \698\ Academic literature suggests that time-to-execution
information would be especially useful for institutional investors
with short-lived private information, who profit from trading
against other, slower institutions. See, e.g., Ohad Kadan, Roni
Michaely & Pamela C. Moulton, Trading in the Presence of Short-Lived
Private Information: Evidence from Analyst Recommendation Changes,
53 J. Fin. Quantitative Analysis 1509 (2018). Time-to-execution
information would also benefit institutions that engage in market
making, as one study shows these institutions are likely to rely on
speed to reduce their exposure to adverse selection and to relax
their inventory constraints. See Jonathan Brogaard, Bjorn
Hagstr[ouml]mer, Lars Nord[eacute]n & Ryan Riordan, Trading Fast and
Slow: Colocation and Liquidity, 28 Rev. Fin. Stud. 3407 (2015).
---------------------------------------------------------------------------

(5) Effective and Realized Spreads
    The Commission believes that current requirements in Rule 605
related to measures of effective and realized spreads may lead to
uninformative or incomplete information.
    First, because of the increase in the speed at which markets
operate,\699\ the requirement to use a five-minute benchmark to
calculate realized spreads \700\ may limit the ability of the Rule 605
realized spreads to measure what they are intended to measure, i.e.,
the adverse selection risk associated with providing liquidity at a
market center. Liquidity providers face adverse selection risk when
they accumulate inventory, for example by providing liquidity to more
informed traders, because of the risk of market prices moving away from
market makers before they are able to unwind their positions.\701\
Realized spreads are calculated by comparing an order's transaction
price to the NBBO midpoint five minutes later (i.e., an estimate of the
average expected trade price). Smaller (or even negative) realized
spreads reflect that market prices have moved away from market makers,
which is usually a reflection of order flow with

greater adverse selection risk. Therefore, all else being equal, if a
market center reports favorable execution quality measures but a low or
negative realized spread, this would reflect that the market center is
still providing liquidity even during adverse market conditions.
---------------------------------------------------------------------------

    \699\ See supra section VII.C.2.(c)(4) for a discussion of
evidence of increased market trading speeds.
    \700\ See 17 CFR 242.600(b)(9). See also supra note 359 and
accompanying text for a further discussion of the definition of the
realized spread.
    \701\ For example, if a liquidity provider provides liquidity to
an informed trader, who is selling its shares because it knows that
the share price is about to drop, the market maker will accumulate a
long position in the stock. If the market maker were to immediately
try to unwind this position in the market, the share price may have
already dropped and the market maker will have to sell at a lower
price than what it paid for the shares.
---------------------------------------------------------------------------

    Selecting an appropriate time horizon to calculate the realized
spread must strike a balance between too short, which could distort the
measures by transitory price impact, and too long, which could measure
noise \702\ or the cumulative impact of subsequent market changes which
are unrelated to the order's execution quality. 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, which is not easily observable. A number of
academic studies argue that the five-minute horizon is too long for a
high-frequency environment.\703\ As one paper puts it, ``five minutes
is a `lifetime', and so is not a meaningful time frame in which to
evaluate trading.'' \704\ Another paper shows that realized spreads
will generally increase as the time horizon that they are calculated
over is shortened, highlighting that realized spreads are highly
dependent on the time horizon over which they are calculated.\705\
---------------------------------------------------------------------------

    \702\ The term ``noise'' is used throughout in the statistical
sense and refers to unexplained or unrelated variability in
observations that degrades the efficiency of computed statistics or
estimators.
    \703\ See, e.g., O'Hara 2015; O'Hara et al.; Conrad and Wahal.
    \704\ See O'Hara 2015. The author argues that the use of a five-
minute time horizon to calculate realized spreads leads to spreads
that are nearly always negative, which is inconsistent with their
interpretation as returns to market-making. The implication is that
the five-minute time horizon is too noisy.
    \705\ See Conrad and Wahal.
---------------------------------------------------------------------------

    In order to see how using different time horizons for calculations
of realized spreads can affect comparisons across market centers, using
TAQ data for a sample of 400 stocks in February 2021,\706\ the
Commission calculated the average realized spreads across 15 different
market centers, measured using six different time horizons: 1 second, 5
seconds, 10 seconds, 15 seconds, 1 minute, and 5 minutes. The results
are presented in Figure 13, and support the findings from the empirical
literature, that the choice of time horizon is non-trivial and realized
spreads are generally increasing as the time horizon decreases.\707\
---------------------------------------------------------------------------

    \706\ Using CRSP data from the last trading day in February
2021, the Commission selected 400 stocks, 100 each from 4 size
quartiles: under $100 million, $100 million to $1 billion, $1
billion to $10 billion, and over $10 billion. Within each market cap
group, the Commission split the stocks into 4 quartiles based on
price and selected 25 stocks from each price quartile evenly spaced
within the quartile. The Commission manually replaced 3 stocks in
the smallest size quartile with a price and sized matched stock
because they had very little trading volume. The Commission limited
its analysis to trades during regular market hours without an
irregular sale condition. Analysis derived based on data from CRSP
1925 US Stock Database, Ctr. Rsch. Sec. Prices, U. Chi. Booth Sch.
Bus. (2022).
    \707\ This analysis uses data from prior to the implementation
of the MDI Rules and results may be different following the
implementation of the MDI Rules. Specifically, the NBBO midpoint in
stocks priced higher than $250 could be different under the MDI
Rules than it otherwise would be, resulting in changes in the
estimates for statistics calculated using the NBBO midpoint, such as
realized spreads. While specific numbers might change, the
Commission does not expect the relative variation in realized
spreads across different time horizons to change as a result of the
implementation of MDI. See supra section VII.C.1.(d)(2) for further
discussion.
---------------------------------------------------------------------------

Figure 13: Average Realized Spreads by Market Center and Time Horizon,
February 2021
[GRAPHIC] [TIFF OMITTED] TP20JA23.013

BILLING CODE 8011-01-C

    These differences can have implications for comparisons across
market centers as well. As shown in Figure 13, while Market Centers 8
and 9 have positive realized spreads using the shortest time horizon,
their spreads are mostly negative at longer time horizons. As a result,
an assessment of whether these market centers have higher or lower
realized spreads (i.e., more or less adverse liquidity conditions) as
compared to, say, Market Center 6, depends on the time horizon used.
Therefore, the choice of interval can not only affect the
interpretation of realized spreads as a measure of liquidity
conditions, but also affect comparisons across market centers.
    From the results of this analysis, it is unclear whether the choice
of any specific measurement horizon results in realized spreads more
accurately measuring adverse selection risk, as the ``ideal''
measurement horizon is not easily observable. However, given the higher
frequency of trading today, it is likely that the use of a five-minute
horizon for realized spreads limits the extent to which these measures
are able to capture adverse selection risk, making it more difficult to
compare conditions for liquidity providers across market centers.
    Second, reporting entities are currently not required to include
information about the effective spreads of NMLOs in Rule 605 reports,
which means that neither individual nor institutional investors have
access to information about this dimension of execution quality for
their NMLOs. The effective spread is calculated by comparing the trade
execution price to the midpoint of the prevailing NBBO at the time of
order receipt, which is used as an estimate of the stock's value.\708\
For market and marketable limit orders, the effective spread captures
how much more than the stock's estimated value a trader has to pay for
the immediate execution of its order. For NMLOs, instead of capturing a
cost of immediacy, the effective spread captures how much the limit
order provider expects to earn (i.e., pay less than or receive more
than the stock's estimated value, depending on whether its order is to
buy or sell) from the execution of its limit order.\709\ This measure
of the expected benefits to liquidity provision contains information
that may otherwise be useful to investors, but is currently missing in
Rule 605 reports.\710\
---------------------------------------------------------------------------

    \708\ See, e.g., Bjorn Hagstr[ouml]mer, Bias in the Effective
Bid-Ask Spread, 142 J. Fin. Econ. 314 (2021). See infra section
VII.E.3.(c)(3) discussing potential issues with using the midpoint
to calculate effective spreads.
    \709\ The interpretation of effective spreads for NMLOs is
different from that of realized spreads. Effective spreads capture
what liquidity providers expect to earn from providing liquidity,
assuming that prices do not change before the liquidity provider is
able to unwind its position and realized its profit. Meanwhile,
realized spreads capture what it actually earns, taking into account
that the market price may have moved against the liquidity provider
before it could unwind its position. See supra note 701 and
accompanying text. Therefore, while the effective spread measures
the expected benefits to liquidity provision, the realized spreads
measure its riskiness.
    \710\ Both individual and institutional investors provide
liquidity through the use of NMLOs. See supra note 680.
---------------------------------------------------------------------------

    Lastly, the fact that Rule 605 reports only contain information on
average realized and average effective spreads in terms of dollar
amounts makes it difficult for market participants to account for
differences in share prices when comparing across market centers.\711\
While spreads in dollar terms can be useful for participants because
they can reflect a cost of (or benefit to) trading in terms that are
easy to interpret, it is also the case that, since the effective spread
is a per-share cost, the real costs to investors captured by the
effective spread can be very different, depending on the stock
price.\712\ All else being equal, spread measures tend to be higher in
dollar terms for higher-priced stocks. As different reporting entities
handle and/or transact in different mixes of stocks, this may make it
difficult for market participants who may want to compare reporting
entities' overall price performance or their performance for baskets of
stocks to aggregate across effective spreads.\713\
---------------------------------------------------------------------------

    \711\ In theory, market participants could also control for
differences in share prices by matching up stock-level information
from Rule 605 reports to, e.g., information on the stock's average
stock price from that month. However, this would require market
participants who wish to control for differently-priced stocks to go
through the extra step of gathering and matching stock price
information to Rule 605 data, which may be an unreasonable
expectation, particularly for individual investors with limited
resources. Furthermore, while a monthly average might well capture
the prevailing stock price for any given execution for a stock with
low price volatility, it might not be a good representation of the
prevailing stock price for executions in stocks with high price
volatility.
    \712\ To illustrate, consider an investor that wants to acquire
a $10,000 position in a $250 stock with an effective spread of
$0.01; the investors will have to pay about $0.40 to purchase 40
shares of the stock. Now consider an investors who wants to acquire
a $10,000 position in a $2.50 stock with an effective spread of
$0.01; the investor would have to pay around $4.00 to acquire 400
shares. In other words, even though the dollar effective spread was
the same, it was ten times more expensive for the investor to
accumulate a position worth the same dollar amount in the lower-
priced stock.
    \713\ While the main purpose of Rule 605 is to facilitate
comparisons across reporting entities on the basis of execution
quality within a particular security, the Commission understands
that access to aggregated information is useful for market
participants. The proposed amendment to require reporting entities
to prepare summary reports that aggregate execution quality
information for S&P 500 stocks, along with all NMS stocks, would
give market participants access to aggregate effective spreads for
one commonly used basket of stocks. Meanwhile, per-stock percentage
spread information would enhance market participants' ability to
aggregate effective spread information across baskets of stocks
other than the S&P 500.
---------------------------------------------------------------------------

    Also, measuring spreads in absolute terms may lead to comparisons
across reporting entities that do not take into account potential
differences in the timing of order flow, particularly for stocks whose
prices vary significantly over the course of the monthly reporting
period. For example, say that a stock's price increased dramatically
over the course of a month from $2.50 to $250 and that, by chance,
Market Center A executed more order flow for that stock at the
beginning of the month, while Market Center B executed more order flow
for that stock at the end of the month. In its Rule 605 report for that
month, Market Center A showed an average effective spread of $0.01,
while Market Center B showed an average effective spread of $0.10.
Measured in dollar terms, Market Center B would seem to have offered
worse execution prices than Market Center A, since it is associated
with higher effective spreads. However, relative to the stock price,
Market Center B would actually have the offered the better prices (a
percentage effective spread of 0.04%) compared to Market Center A (a
percentage effective spread of 0.4%).\714\ This illustrates that a
market center's spread measures may be higher in dollar terms, but not
necessarily because it offered worse execution performance; instead,
these differences in spread measures may simply reflect changes in the
stock's dollar price and the timing of market center's order flow.
---------------------------------------------------------------------------

    \714\ To illustrate how the percentage effective spread can
reflect different costs in real terms, consider if one customer
acquired a $10,000 stake in the stock at the beginning of the month
(i.e., $10,000/$2.50 = 4,000 shares); a per-share effective spread
of $0.01 means that the customer's cost of acquiring the position
would have been $40. Meanwhile, another customer acquired a $10,000
stake at the end of the month (i.e., $10,000/$250 = 40 shares); a
per-share effective spread of $0.10 means that the customer's cost
would have been only $4.
---------------------------------------------------------------------------

(6) Price and Size Improvement
    The current measure of price improvement required for Rule 605
reports may not succeed in always capturing price improvement relative
to the best available prices. Currently, market centers are required to
report price improvement as the difference between the trade price and
the NBBO.

However, a recent academic working paper shows that odd-lots offer
better prices than the NBBO 18% of the time for bids and 16% of the
time for offers.\715\ If an order executes against a resting odd-lot
with a price better than the NBBO, the execution would result in
positive price improvement according to the current Rule 605 reporting
requirements. In cases where this occurs, this positive price
improvement is the result of an inadequate benchmark price being used,
and not the same as if the market center were to actively offer the
order at a price better than the best available market price, which is
what price improvement is typically intended to measure.
---------------------------------------------------------------------------

    \715\ See Bartlett et al. (2022). The authors found that this
percentage increases monotonically in the stock price, for example,
for bid prices, increasing from 5% for the group of lowest-price
stocks in their sample, to 42% for the group of highest-priced
stocks.
---------------------------------------------------------------------------

    Furthermore, such positive price improvement may actually reflect
price dis-improvement, once all available displayed liquidity is taken
into account. For example, if a market center internalizes an order
with $0.05 of price improvement relative to the NBBO, but odd-lots are
available on another market center at prices that are $0.10 better than
the NBBO, the market center would post a price improvement measure of
$0.05, even though the investor could have received a better price if
the market center had routed the order to execute against the available
odd-lot liquidity instead of internalizing the order. As a result,
current measures of Rule 605 may overstate the amount of price
improvement offered by some market centers.
    Information about price improvement is different from information
about whether orders received an execution of more than the displayed
size at the quote, i.e., ``size improvement.'' The price improvement
metrics currently required by Rule 605 do not necessarily capture a
market center's ability to fill orders beyond the liquidity available
at the NBBO.\716\ For example, consider a situation in which the market
is $10.05 x $10.10 with 100 consolidated shares available at the NBO of
$10.10 and 100 consolidated shares available at the next best ask price
of $10.15. Say that a trader submits a marketable buy order for 200
shares to a market center, which fills the entire order at the best ask
price of $10.10. The market center's Rule 605 statistics would reveal a
price improvement metric of $0 for this order, despite the fact that
the trader saved money by avoiding having to walk the book, which would
have resulted in a total price of (100 * $10.10) + (100 * $10.15) =
$2,025. As a result of the market center's ability to offer this ``size
improvement,'' the trader saved an average of $10.125 $- $10.10 =
$0.025 per share. This information about execution quality is not
reflected in the market center's price improvement statistics.
---------------------------------------------------------------------------

    \716\ An analysis of data from the Tick Size Pilot B.II Market
and Marketable Limit Order dataset reveals that nearly 7% of orders
had sizes greater than the liquidity available at the NBBO between
April 2016 and March 2019. See infra note 723 for data description.
See also supra note 406 and accompanying text. This analysis uses
data from prior to the implementation of the MDI Rules and results
may be different following the implementation of the MDI Rules.
Specifically, the MDI Rules could result in a smaller number of
shares at the NBBO for stocks in higher-priced round lot tiers,
increasing the number of orders with sizes greater than the NBBO.
See supra section VII.C.1.(d)(2) for further discussion.
---------------------------------------------------------------------------

    As the Commission stated in the Adopting Release, the average
effective spread captures some information about size improvement.\717\
The effective spread is calculated by comparing the trade execution
price with the midpoint of the NBBO, rather than with the NBBO itself.
In this way, it captures the full range of available liquidity at a
market center and not merely the displayed orders that determine the
NBBO. The effective spread will be larger for orders that are larger
than liquidity available at the NBBO and are required to walk the book.
Therefore, generally speaking, a market center that offers greater size
improvement will tend to have a lower average effective spread (i.e.,
these measures will be negatively correlated).\718\ However, as this
measure contains information about both size and price, it may be
difficult to disentangle information about size improvement from
information about price improvement when interpreting average effective
spreads.\719\ Therefore, investors that particularly value the ability
of market centers to offer size improvement, such as investors trading
in larger order sizes, would not currently be able to use the metrics
currently contained in Rule 605 reports to easily discern which market
center would better handle their order according to this dimension of
execution quality.\720\
---------------------------------------------------------------------------

    \717\ See Adopting Release, 65 FR 75414 (Dec. 1, 2000) at 75425.
    \718\ For example, assume that a trader submits a marketable buy
order for 100 shares to a $10.05 x $10.10 market with 100
consolidated shares available at the NBO of $10.10 and 100
consolidated shares available at the next best ask price of $10.15.
In this case, the effective spread would be 2 * ($10.10 - $10.075) =
$0.05, reflecting that the trader had to pay an average of $0.05
more per share than the NBBO midpoint. Now consider the situation in
which the trader instead submits a marketable buy order for 200
shares to a market center (``Market Center A'') that walks the order
up the book. In this case the effective spread will be twice as
high, 2 * ($10.125 - $10.075) = $0.10. This higher effective spread
reflects the need for Market Center A to use volume beyond the best
quote to fill the order. If, on the other hand, instead of walking
the 200-share order up the book, a market center (``Market Center
B'') fills the entire buy order at the current NBO of $10.10; the
effective spread would only be $0.05. The ability of Market Center B
to execute an order for more than the displayed size at the quote is
therefore reflected in an effective spread that is lower than that
of Market Center A.
    \719\ To illustrate, consider the example in supra note 718,
but, instead of 200 shares, the trader's order was for 100 shares
and Market Center A executed the order with an average price dis-
improvement of $0.025; the effective spread for Market Center A
would similarly be $0.10. Furthermore, consider a situation in which
the market is wider at $10.12 x $10.02 and Market Center B executes
the 100-share order with an average price improvement of $0.025 per
share, while Market Center A executes it without any price
improvement. Both of these cases would lead to the same effective
spreads (an effective spread of $0.10 for Market Center A, and an
effective spread of $0.05 for Market Center B) as the above-
described scenario in which Market Center B offered size improvement
and Market Center A did not, but for situations in which the order
size is less than or equal to the displayed size at the quote.
    \720\ For example, compare the example of Market Center B
offering size improvement to a 200-share order in note 718, supra,
to the example of Market Center B offering price improvement to a
100-share order in note 719, supra. A trader that tends to submit
200-share orders would want to know a market center's ability to
offer the first scenario, while a trader that tends to submit 100-
share orders would want to know the market center's ability to offer
the second scenario. However, in both examples the Rule 605 report
would show an effective spread statistic of $0.05 for orders in the
order size category of 100-499 shares, which means that these
traders would not be able to use this statistic to discern a market
center's execution quality according to the dimension of execution
quality that they find most valuable.
---------------------------------------------------------------------------

    (7) Marketable IOCs
    The Commission preliminarily believes that grouping marketable IOCs
together with other marketable limit orders may lead to a downward skew
on the execution quality metrics (specifically, derived estimates of
fill rates) for market centers that handle a large amount of IOCs,
which would hinder the extent to which these metrics could be used to
accurately compare execution quality across market centers. At least
one commenter to the 2010 Concept Release on Equity Market Structure
pointed out that IOCs may have a different submitter profile
(typically, institutional investors) and different execution quality
characteristics than other types of orders.\721\ Furthermore, an
analysis using CAT data \722\ of retail orders received at larger
retail brokers during June 2021 indicate that approximately only 0.02%
of individual investor

orders are submitted with an IOC instruction.
---------------------------------------------------------------------------

    \721\ See supra note 326 and accompanying text.
    \722\ See supra note 609 for dataset description.
---------------------------------------------------------------------------

    To examine whether IOC orders have different execution quality
characteristics than other types of orders, an analysis was performed
using data from the Tick Size Pilot B.II Market and Marketable Limit
Order dataset,\723\ which includes a flag indicating whether a market
or marketable limit order has been marked as IOC. The results are
presented in Table 6 and show that IOCs indeed may have different
execution quality, as they typically have much lower fill rates (3.22%)
than other market and marketable limit orders (15.94%), particularly
for larger-sized orders. Therefore, the inclusion of IOCs along with
other types of market and marketable limit orders may skew the
execution quality of these other orders types, particularly since IOCs
make up more than 90% of market and marketable share volume.
---------------------------------------------------------------------------

    \723\ See Tick Size Pilot Plan. This dataset contains
information for approximately 2,400 small cap stocks for a period
from April 2016 to March 2019. Orders with special handling codes
are discarded, as are orders marked as short sales (``SS''). Note
that, as the Tick Size Pilot collected data only for small cap
stocks, these time-to-executions are not necessarily representative
of all stocks. For example, larger market cap stocks may be traded
more actively by institutional investors, and therefore would likely
have higher IOC volumes.

                   Table 6--Immediate-or-Cancel (IOC) Share Volume, October 2018-October 2019
----------------------------------------------------------------------------------------------------------------
                                                                IOC volume (%
                                                                   of share     Fill rate (IOC)  Fill rate (non-
                                                                   volume)                             IOC)
----------------------------------------------------------------------------------------------------------------
Market Centers Other than Wholesalers:
    Less than 100 shares.....................................             88.1             39.6             15.4
    100 to 499 shares........................................             88.9             14.8             11.5
    500 to 1,999 shares......................................             84.6              5.4              6.5
    2,000 to 4,999 shares....................................             89.3              3.0              8.1
    5,000 to 9,999 shares....................................             91.6              1.3              7.5
    10,000 or more shares....................................             92.8              0.3              3.8
Wholesalers:
    Less than 100 shares.....................................             33.6             30.1             67.1
    100 to 499 shares........................................             70.7             13.4             48.1
    500 to 1,999 shares......................................             66.6              5.6             95.0
    2,000 to 4,999 shares....................................             54.8              4.3             93.7
    5,000 to 9,999 shares....................................             59.0              2.1             84.5
    10,000 or more shares....................................             83.8              0.3             60.7
All Market Centers and Order Sizes...........................            90.04             3.22            15.94
----------------------------------------------------------------------------------------------------------------
Table 6: Immediate-Or-Cancel (IOC) Share Volume, October 2018-October 2019. This table shows the percentage of
  market and marketable limit orders submitted with IOC instructions, along with the fill rates of those orders,
  using data from the Tick Size Pilot B.II Market and Marketable Limit Order dataset. See supra note 723 for
  data description. This dataset contains an ``IOC'' flag, which is equal to ``Y'' if the order is an IOC order.
  The Commission excluded orders outside of regular trading hours and identified retail wholesaler orders as
  orders originating from seven trading center codes that the Commission understands to be retail wholesalers.

    This is especially likely to be the case for wholesalers. The
Commission understands that IOC orders received by wholesalers are
typically institutional orders that are pinged in the wholesalers' SDPs
to see if any contra-side volume is available. This is supported by
Table 6, which shows that the differences between fill rates for IOC
and non-IOC orders are particularly stark for these market centers:
While wholesaler fill rates range between 60% and 95% for non-IOC
orders, they are mostly below 30% for IOC orders, and even smaller for
larger order sizes, dropping to just 0.3% for orders for 10,000 shares
or more. This is again consistent with the idea that wholesalers' IOC
orders may represent institutional orders that are routed to their
SDPs. Co-mingling SDP activity with other market center activity may
obscure differences in execution quality or distort the general
execution quality metrics for the market center.\724\ Similarly,
grouping together IOC orders along with other types of market and
marketable orders could impose a significant downwards skew on the fill
rates, in particular for larger order sizes and orders handled by
wholesalers. This may impact market centers' incentives to achieve
better execution quality for marketable orders.\725\
---------------------------------------------------------------------------

    \724\ See supra section VII.C.2.(a)(2) for further discussion of
co-mingling SDP activity with other market center activity.
    \725\ For example, if a market center's Rule 605 reports reveals
low fill rates for market orders simply because it handles a large
amount of marketable IOCs, it may not be incentivized to improve its
fill rates for other types of market orders since the higher fill
rates of these orders would be obscured by the low fill rates of
marketable IOCs.
---------------------------------------------------------------------------

(8) Riskless Principal Orders
    The Commission believes that current reporting of riskless
principal transactions \726\ leads to the duplicative reporting of
these orders, and creates uncertainty about how many orders are
internalized by off-exchange market centers, particularly wholesalers.
---------------------------------------------------------------------------

    \726\ See supra note 416 and accompanying text for a definition
and discussion of riskless principal transactions.
---------------------------------------------------------------------------

    In a riskless principal transaction, a market center routes a
principal order to a second market center, typically an exchange or
ATS, in order to fulfill a customer order; upon execution at the second
market center, the first market center executes the customer
transaction on the same terms as it received from the principal
execution at the second market center. Currently, for the purposes of
Rule 605 reporting, both the first and second market centers in this
example would report the riskless principal transaction as having been
executed at the market center under Rule 605(a)(1)(i)(D), rather than
as a part of the cumulative number of shares of covered orders executed
at any other venue under Rule 605(a)(1)(i)(E).\727\
---------------------------------------------------------------------------

    \727\ See supra note 417 and accompanying text. In contrast, for
the purposes of SIP reporting, the away market center is required to
report the principal transaction to the tape, while the receiving
market center would post a non-tape (regulatory or clearing-only)
report to reflect the offsetting riskless customer transaction. When
the initial leg of the transaction takes place on and is reported
through an exchange, members are instructed not to report the
customer transaction for public dissemination purposes, as that
would result in double (tape) reporting of the same transaction. See
Trade Reporting Frequently Asked Questions, answers to Questions
302.2 and 302.4, available at https://www.finra.org/filing-reporting/market-transparency-reporting/trade-reporting-faq.

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

    The Commission believes that, particularly in the case of riskless
principal transactions that are handled by wholesalers, grouping
transactions that are handled on a riskless principal basis together
with other orders executed at the market center under Rule
605(a)(1)(i)(D) may obscure information about the extent to which
wholesalers internalize orders. Wholesalers primarily choose between
two options to execute the individual investor orders that they handle:
they either internalize orders by executing orders against their own
capital, or they execute orders on a riskless principal basis.\728\
While wholesalers' internalized orders are not exposed to competition
from other interested parties quoting on external market centers, their
riskless principal executions expose individual investor orders to
trading interest from market participants other than the wholesaler,
which has potential implications for differences in execution quality
between these two order types. Currently, both types of orders would be
categorized together as orders executed at the market center under Rule
605(a)(1)(i)(D), so market participants would not be able to tell from
Rule 605 reports whether a wholesaler internalizes the majority of its
individual investor order flow, or executes the majority as riskless
principal. Thus, key information that would be useful for investors
(particularly individual investors, whose orders are overwhelmingly
handled by wholesalers \729\) when interpreting and comparing
information about wholesalers' execution quality is currently missing
from Rule 605 reports.
---------------------------------------------------------------------------

    \728\ See infra section VII.C.3.(b)(1) for further discussion of
the market for trading services, which includes wholesalers.
    \729\ See supra note 614 for results from an analysis of retail
brokers' routing practices.
---------------------------------------------------------------------------

(d) Accessibility of Current Rule 605 Reports
    Rule 605 currently requires market centers to post their monthly
reports on an internet website that is free of charge and readily
accessible to the public.\730\ There is currently no system or
requirement in place for the centralized posting of Rule 605 reports,
which results in search costs for market participants. In order to
collect 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, a market participant would need to perform
the following tasks, for each of the estimated 236 reporting entities
that are currently required to prepare Rule 605 reports: \731\ first,
search the internet for the website(s) of the reporting entity; second,
find the area of the reporting entity's website(s) that links to its
Rule 605 report; and third, find the correct link and download the
appropriate report (or multiple reports, if the information for
multiple months is desired).
---------------------------------------------------------------------------

    \730\ See 17 CFR 242.605(a)(2) (requiring market centers to make
their Rule 605 reports ``available for downloading from an internet
website that is free and readily accessible to the public. . . .'').
    \731\ See supra section VI.C for a discussion of the estimated
number of reporting entities under the proposed amendments.
---------------------------------------------------------------------------

    The process of collecting Rule 605 reports may be simplified by the
NMS Plan's requirement that each market center must designate a single
Participant to act as the market center's Designated Participant, who
is tasked with maintaining a comprehensive list of the hyperlinks
provided by its market centers.\732\ Furthermore, certain reporting
entities' use of third-party vendors to prepare and/or collect Rule 605
reports may also simplify the process of collecting Rule 605 reports,
as these vendors typically maintain a centralized repository of the
reports that they handle.\733\ However, because an individual vendor or
Designated Participant may only offer a subset of Rule 605 reports or
hyperlinks to reports, which may not be a representative sample of
reports, it is still the case that collecting the complete or even a
mostly comprehensive set of Rule 605 reports could entail search
costs.\734\ In order to collect a complete set of reports, market
participants may still need to search the websites of and collect
reports from multiple vendors or Designated Participants.
---------------------------------------------------------------------------

    \732\ See Section VIII of the Rule 605 NMS Plan. For a
description of ``Designated Participant'' as defined in the Plan,
see supra note 47.
    \733\ See, e.g., Disclosure of SEC--Required Order Execution
Information, S&P Global, available at https://vrs.vista-one-solutions.com/sec605rule.aspx.
    \734\ For these reasons and others, EMSAC has suggested
considering a centralized location for 605 reports. See EMSAC
Recommendations Regarding Rule 605 and 606, SEC, 4, available at
https://www.sec.gov/spotlight/emsac/emsac-recommendations-rules-605-606.pdf (stating that ``To further improve standardization and the
consistency of reporting, the SEC could consider centralizing report
creation in an unbiased and trusted source such as FINRA.''). The
Commission also notes that FINRA has proposed requiring members to
submit Rule 606(a) order routing reports to FINRA for publication on
the FINRA website. See Report from FINRA Board of Governors Meeting,
FINRA (Mar. 2022), available at https://www.finra.org/media-center/newsreleases/2022/report-finra-board-governors-meeting-march-2022
(describing proposed amendments to centrally host SEC Rule 606(a)
reports).
---------------------------------------------------------------------------

3. Markets for Brokerage and Trading Services for NMS Stocks Under
Current Rule 605 Disclosure Requirements
(a) Brokerage Services for NMS Stocks
(1) Current Structure of the Market for Brokerage Services
    Based on information from broker-dealers' FOCUS Report Form X-17A-5
Schedule II, there were 3,498 registered broker-dealers as of Q2 2022.
A portion of these broker-dealers focus their business on individual
and/or institutional investors in the market for NMS stocks.\735\ These
include both carrying broker-dealers, who maintain custody of customer
funds and securities, and introducing broker-dealers, who accept
customer orders and introduce their customers to a carrying broker-
dealer that will hold the customers' securities and cash.\736\ The
Commission estimates that there are approximately 153 broker-dealers
that carry at least one customer trading in NMS stocks and
options,\737\ and 1,110 broker-dealers that introduce at least one
customer trading in NMS stocks and options.\738\
---------------------------------------------------------------------------

    \735\ Some broker-dealers service only the accounts of other
brokers, which are excluded from the definition of customers. See
supra note 140 for a definition of ``customer.''
    \736\ See supra note 174 for a description of introducing and
carrying broker-dealers. Some firms operate a hybrid introducing/
carrying broker-dealer by introducing on a fully disclosed basis to
a carrying broker-dealer those customers that trade securities for
which the broker-dealer is not prepared to provide a full range of
services. See, e.g., Securities Exchange Act Release No. 70073 (Aug.
21, 2013), 78 FR 51910 (Aug. 21, 2013) at 51911, 51949, and 51968.
    \737\ This number is based on the number of broker-dealers that
report carrying at least one customer on their 2021 FOCUS Schedule I
reports.
    \738\ This number is based on estimates using broker-dealers
FDIDs identified in CAT data during the 2021 calendar year. As CAT
data only includes information about NMS stocks and options, broker-
dealers that introduce or carry customers trading in other assets
classes are not included in these numbers. See infra note 1008 for a
discussion of the data and methodology for identifying introducing
broker-dealers.
---------------------------------------------------------------------------

    When a customer places an order in an NMS stock with a broker-
dealer, the broker-dealer acts as an agent on behalf of that customer,
who generally wants to receive the best possible execution of their
order.\739\ These broker-dealers can generally decide how to route that
order for execution to an exchange, a wholesaler, or an ATS, where the
trade

may be executed or potentially routed further. The high level of
fragmentation of NMS stock trading \740\ means that broker-dealers have
a variety of choices for order routing and execution, and the venue
that a broker-dealer chooses may have a tangible effect on the
execution quality of an order.
---------------------------------------------------------------------------

    \739\ Some investors may not value order-level execution quality
in all cases. For example, it is the Commission's understanding that
when an institutional customer submits a large order to be executed
on behalf of one account (e.g., a single mutual fund or pension
fund), it expects the broker-dealer that handles and executes such
large order to do so in a manner that ensures best execution is
provided to the ``parent'' order. See infra section
VII.C.3.(a)(1)(b) for further discussion.
    \740\ See infra section VII.C.3.(b)(1) for a breakdown of
trading in NMS stocks across various types of trading venues.
---------------------------------------------------------------------------

    A broker-dealer has a legal duty to seek best execution of customer
orders. The duty of best execution predates the federal securities laws
and is derived from an implied representation that a broker-dealer
makes to its customers.\741\ The duty is established from ``common law
agency obligations of undivided loyalty and reasonable care that an
agent owes to [its] principal.'' \742\ This obligation requires that a
``broker-dealer seek to obtain for its customer orders the most
favorable terms reasonably available under the circumstances.'' \743\
---------------------------------------------------------------------------

    \741\ See, e.g., Newton v. Merrill, Lynch, Pierce, Fenner &
Smith, Inc., 135 F.3d 266, 270 (3d Cir.), cert. denied, 525 U.S. 811
(1998).
    \742\ See id.
    \743\ See id. See also Securities Exchange Act Release No.
37619A (Sept. 6, 1996), 61 FR 48290 (Sept. 12, 1996) (``Order
Execution Obligations Adopting Release''). A Report of the Special
Study of Securities Markets stated that ``[t]he integrity of the
industry can be maintained only if the fundamental principle that a
customer should at all times get the best available price which can
reasonably be obtained for him is followed.'' See SEC Report of the
Special Study of Securities Markets, H.R. Doc. No. 95, 88th Cong.,
1st Sess. Pt. II, 624 (1963) (``Special Study'').
---------------------------------------------------------------------------

    Investors may incur switching costs when changing broker-dealers,
such as the cost of withdrawing or transferring funds and potential
administrative fees. Switching broker-dealers could also involve time
delays resulting in lost investment opportunities or revenues and other
opportunity costs.\744\ Furthermore, some customers that rely on
broker-dealers' non-execution-related services, such as providing
recommendations, holding customers' funds and securities and/or
providing analyst research, may find it more costly to switch broker-
dealers, as these services would be more difficult to transfer across
broker-dealers. However, the Commission understands that some broker-
dealers, including some that cater to individual investors, will
compensate new customers for transfer fees that their outgoing broker-
dealer may charge them, which would result in lower (or even zero)
switching costs.\745\ The Commission understands that some investors,
particularly institutional investors, are likely to use multiple
broker-dealers,\746\ which would tend to lead to lower switching costs
as a customer that is unhappy with one broker-dealer could simply use
one of their other broker-dealers to handle those orders.
---------------------------------------------------------------------------

    \744\ See, e.g., Understanding the Brokerage Account Transfer
Process, FINRA, available at https://www.finra.org/investors/learn-to-invest/brokerage-accounts/understanding-brokerage-account-transfer-process.
    \745\ See, e.g., Scott Connor, Thinking about Switching to TD
Ameritrade? Transferring is Easier than You Might Think, TD
Ameritrade (Oct. 17, 2019), available at https://tickertape.tdameritrade.com/investing/how-to-switch-brokers-17755
(``If your broker does charge you a transfer fee, TD Ameritrade will
refund you up to $100.'').
    \746\ For example, one academic paper finds that institutional
investors tend to break up larger orders and spread them out across
multiple broker-dealers, as a strategy to avoid information leakage.
See, e.g., Munhee Han & Sanghyun (Hugh) Kim, Splitting and
Shuffling: Institutional Trading Motives and Order Submissions
Across Brokers (working paper Sept. 30, 2020), available at https://ssrn.com/abstract=3429452 (retrieved from SSRN Elsevier database).
---------------------------------------------------------------------------

    The Commission understands that the structure of the market for
brokerage services can broadly be separated into two distinct markets--
brokerage services for individual investors on the one hand, and
brokerage services for institutional investors on the other--that
differ somewhat in terms of their market structure.
(a) Brokerage Services for Individual Investors
    As of the end of 2021, there were approximately 1,037 registered
broker-dealers that originated orders on behalf of individual investors
in the market for NMS stocks.\747\ Unlike institutional investors,
individual investors generally use a single broker to handle their
orders. Retail brokers can broadly be divided into ``discount'' brokers
and ``full-service'' brokers.\748\ Competition between discount brokers
for the business of individual investors in particular has recently
resulted in many new entrants and a decline in commissions to zero or
near zero.\749\ Instead of commissions on certain transaction, these
discount brokers earn revenue through other means, including, among
other products and services, interest on margin accounts and from
lending securities, as well as broker-wholesaler arrangements involving
PFOF paid by the wholesaler to the retail broker. Discount broker-
dealers can distinguish themselves by the accessibility and
functionality of their trading platform, which can be geared towards
less experienced or more sophisticated investors, and by providing more
extensive customer service as well as tools for research and education
on financial markets.
---------------------------------------------------------------------------

    \747\ This number is estimated using the CAT data described
infra in note 1008. Individual investor accounts are identified in
CAT as accounts belonging to the ``Individual Customer'' account
type, defined as accounts that do not meet the definition of FINRA
Rule 4512(c) and are also not proprietary accounts. See supra note
609 for more information about account types in CAT.
    \748\ Note that there is not necessarily a precise delineation
between full-service and discount brokers. Discount brokers
generally provide execution-only services, typically at a reduced or
zero commission rate. Full-service brokers (as they are commonly
called) typically charge commissions in exchange for a package of
services, including execution, incidental investment advice, and
custody. See, e.g., Interpretive Rule Under the Advisers Act
Affecting Broker-Dealers, Advisers Act Release No. 2652 (Sept. 24,
2007), notes 2 and 20.
    \749\ See, e.g., Samuel Adams & Connor Kasten, Retail Order
Execution Quality under Zero Commissions, (working paper Jan. 7,
2021), available at https://ssrn.com/abstract=3779474 (retrieved
from SSRN Elsevier database), describing how ``on October 1st, 2019,
Charles Schwab announced that they would cut commissions from $4.95
per trade to zero on all retail trades starting on October 7th.
Within hours, TD Ameritrade followed by announcing they would cut
commissions to zero from $6.95 beginning on October 3rd. By January
3rd, Vanguard, Fidelity, and E*TRADE had joined the trend in
offering free equity trades for retail investors.''
---------------------------------------------------------------------------

(b) Brokerage Services for Institutional Investors
    As of the end of 2021, there were approximately 909 registered
broker-dealers that originated institutional orders in the market for
NMS stocks.\750\ One feature that distinguishes the market for
institutional brokerage services is that a significant portion of
institutional investor orders are generally ``not held'' orders.\751\ A
broker-dealer has time and price discretion in executing a not held
order, and institutional investors in particular rely on such
discretion for various reasons including minimizing price impact.\752\
Due to the large size of institutional trading interests, broker-
dealers will often split orders when handling their orders, often
through the use of SORs. Specifically, a broker-dealer or its SOR will
split up a ``parent'' order into multiple ``child'' orders, with the
goal of executing the child orders in a way that achieves the

best execution for the parent order.\753\ For example, a broker-dealer
may not execute a child order at the best price, if doing so could
result in a larger price impact and increases the overall cost of
working a parent order. For this reason, most institutional parent
orders are handled by broker-dealers on a not held basis, which would
exclude these orders from Rule 605 execution quality disclosure
requirements.\754\ However, since 2018, broker-dealers are required by
Rule 606(b)(3) to provide individualized reports of execution quality
of not held orders upon request.\755\
---------------------------------------------------------------------------

    \750\ This number is estimated using the CAT data described in
infra note 1008. Institutional investor accounts are identified in
CAT as accounts belonging to the ``Institutional Customer'' account
type, defined as accounts that meet the definition in FINRA Rule
4512(c). See supra note 609 for more information about account types
in CAT.
    \751\ See supra note 538 discussing an analysis showing that
institutional investors are more likely than individual investors to
use not held orders.
    \752\ See 2018 Rule 606 Amendments Release, 83 FR 58338 nn.60-61
and corresponding text. Meanwhile, a broker-dealer must attempt to
execute a held order immediately, which typically better suits
individual investors who seek immediate executions and rely less on
broker-dealer order handling discretion.
    \753\ See Tyler Beason & Sunil Wahal, The Anatomy of Trading
Algorithms, (working paper Jan. 21, 2021), available at https://ssrn.com/abstract=3497001 (retrieved from SSRN Elsevier database).
    \754\ Note that some child orders may be held orders and thus
would be required to be included in Rule 605 reports.
    \755\ See supra note 60 and accompanying text discussing broker-
dealers requirements under Rule 606(b)(3) to provide individualized
reports of execution quality upon request for not held orders.
---------------------------------------------------------------------------

(2) Competition Between Broker-Dealers on the Basis of Execution
Quality
    Broker-dealers compete with one another along a variety of
dimensions,\756\ including the execution quality that they offer, and
make their execution quality known in a variety of ways. For example,
at least one broker-dealer published execution quality reports using
the FIF template,\757\ and furthermore some broker-dealers disclose
their own execution quality metrics on their websites.\758\ Broker-
dealers may seek to improve their competitive position on the basis of
execution quality by, for example, investing in the speed and quality
of their routing technology. Broker-dealers may also compete on the
basis of execution quality by reevaluating their routing strategies to
increase the extent to which they route orders to the market centers
offering better execution quality.
---------------------------------------------------------------------------

    \756\ For example, broker-dealers may compete by charging lower
commissions for trading, or by offering a wider range of services or
functionalities, such as trading in additional asset classes such as
options.
    \757\ See supra note 554.
    \758\ See supra note 506 for examples.
---------------------------------------------------------------------------

    As discussed above,\759\ when making routing decisions, some
broker-dealers may face conflicts of interest that misalign their
interests with their customers' interest in receiving better execution
quality. These conflicts of interest could result, for example, from
broker-dealer affiliations with market centers. Some broker-dealers
operate or are otherwise affiliated with ATSs, which implies a possible
conflict of interest relative to their customers' best interests in
that these broker-dealers may give preference to routing orders to
their own ATSs, where they typically pay lower transaction fees, even
if their customer would have received better execution quality if the
order were routed to another trading venue. At least one academic study
has shown that broker-dealers that route orders to their ATSs obtain
worse execution quality.\760\ Similarly, presence of liquidity fees and
rebates on some market centers may incentivize broker-dealers to make
routing decisions based on where they can receive the highest rebate
(or pay the lowest fee), rather than where they can receive better
execution quality on behalf of their customer.\761\ For example, a
recent research paper analyzed the relation between maker-taker fee
schedules and order routing, and found a negative relation between take
fees and limit order execution quality.\762\ Another potential conflict
of interest, particularly with regard to individual investor order
flow, includes the receipt of PFOF, which may result in broker-dealers
routing orders to wholesalers as a result of the terms of the PFOF
arrangements.\763\
---------------------------------------------------------------------------

    \759\ See supra section VII.C.2.(a)(1).
    \760\ See Amber Anand, Mehrdad Samadi, Jonathan Sokobin & Kumar
Venkataraman, Institutional Order Handling and Broker-Affiliated
Trading Venues, 34 Rev. Fin. Studies 3364 (2021).
    \761\ See, e.g., Robert H. Battalio, Shane A. Corwin, & Robert
H. Jennings, Can Brokers Have It All? On the Relation Between Make-
Take Fees and Limit Order Execution Quality, 71 J. Fin. 2193 (2016).
    \762\ See id. The authors ``document a strong negative relation
between take fees and several measures of limit order execution
quality. Based on this evidence, [they] conclude that the decision
of some national brokerages to route all nonmarketable limit orders
to a single exchange paying the highest rebate is not consistent
with the broker's responsibility to obtain best execution for
customers.''
    \763\ The study by Schwarz et al. (2022) in supra note 529 does
not find a relationship between the amount of PFOF a retail broker
receives and the amount of price improvement their customers' orders
receive. However, the authors noted that the variation in the
magnitude of price improvement they saw across retail brokers was
significantly greater than the amount of PFOF the retail broker
received, which could indicate their sample was not large enough to
observe a statistically significant effect.
---------------------------------------------------------------------------

    If information asymmetries, such as those resulting from
insufficient public information about broker-dealer execution
quality,\764\ prevent investors from observing differences in execution
quality across broker-dealers, this would limit the extent to which
broker-dealers would need to keep these conflicts of interest in check
and compete on the basis of execution quality.
---------------------------------------------------------------------------

    \764\ See supra section VII.C.2.(a)(1) discussing broker-
dealers' current execution quality reporting requirements.
---------------------------------------------------------------------------

(b) Trading Services for NMS Stocks
(1) Current Structure of the Market for Trading Services
    Trading services for NMS stocks are highly fragmented among
different types of market centers.\765\ Table 7 shows that in Q1 of
2022, NMS stocks were traded on 16 national securities exchanges and
off-exchange at 32 NMS Stock ATSs and at over 230 other FINRA members,
including 6 wholesalers that internalize the majority of individual
investor marketable orders.\766\ National securities exchanges execute
approximately 60% of total share volume in NMS stocks, while off-
exchange market centers execute approximately 40% of total share
volume.\767\ The majority of off-exchange volume is executed by
wholesalers, who execute almost one quarter of total share volume
(23.9%) and about 60% of off-exchange volume. Some OTC market makers,
such as wholesalers, operate SDPs through which they execute
institutional orders in NMS stocks against their own inventory.\768\
SDPs accounted for approximately 4% of total trading volume in Q1
2022.\769\ As of June 2022, the Commission estimates that there are
currently 236 market centers to which Rule 605 applies.\770\
---------------------------------------------------------------------------

    \765\ Some academic studies attribute the highly fragmented
nature of this market to implementation of Regulation NMS. See,
e.g., Maureen O'Hara & Mao Ye, Is Market Fragmentation Harming
Market Quality?, 100 J. Fin. Econ. 459 (2011); Amy Kwan, Ronald
Masulis & Thomas H. MacInish, Trading Rules, Competition for Order
Flow and Market Fragmentation, 115 J. Fin. Econ. 330 (2015).
    \766\ See Concept Release on Equity Market Structure, 75 FR
3594, 3598-3560 (Jan. 21, 2010) (for a discussion of the types of
trading centers); see also Form ATS-N Filings and Information,
available at https://www.sec.gov/divisions/marketreg/form-ats-n-filings.htm. These wholesalers were determined based on marketable
order routing information from retail broker Rule 606(a)(1) reports.
    \767\ This analysis uses data from prior to the implementation
of the MDI Rules. The implementation of the MDI Rules may result in
a change in the flow of orders across trading venues, which may
result in numbers that are different from those reported here.
However, the Commission is uncertain of the magnitude of these
effects. See supra section VII.C.1.(d)(2) for further discussion.
    \768\ See Rosenblatt Securities (2022), US Equity Trading Venue
Guide. Wholesalers and OTC market makers can execute orders
themselves or route orders to be executed on other venues. An SDP
always acts as the counterparty to any trade that occurs on the SDP.
See, e.g., Where Do Stocks Trade?, FINRA (Dec. 3, 2021), available
at https://www.finra.org/investors/insights/where_do_stocks_trade">https://www.finra.org/investors/insights/where_do_stocks_trade.
    \769\ See Rosenblatt Securities (2022), US Equity Trading Venue
Guide.
    \770\ See supra section VI.C for a discussion of this estimate.
Some market centers may not be required to prepare Rule 605 reports,
for example, if they do not handle any covered orders.

                     Table 7--NMS Stock Traded Share Volume Percentage by Market Center Type
----------------------------------------------------------------------------------------------------------------
                                                                                Off-exchange
                                                                                Share volume (%  share volume (%
                      Market center type                          Venue count       of total      of total off-
                                                                                volume)         exchange)
----------------------------------------------------------------------------------------------------------------
NMS Stock ATSs................................................              32             10.2             25.2
National Securities Exchanges.................................              16             59.7  ...............
Wholesalers...................................................               6             23.9             59.4
Other FINRA Members...........................................             232              6.3             15.6
----------------------------------------------------------------------------------------------------------------
Table 7: NMS Stock Traded Share Volume Percentage by Market Center Type. This table reports the percentage of
  all NMS stock executed share volume and the percentage of NMS stock share volume executed off-exchange for
  different types of market centers for Q1 2022, including lists the number of venues in each market center
  category. Exchange share volume and total market volume are based on CBOE Market Volume Data on monthly share
  volume executed on each exchange available at: https://cboe.com/us/equities/market_statistics/historical_market_volume/. NMS Stock ATS, wholesaler and FINRA member share volume are based on monthly data
  from FINRA OTC (Non-ATS) Transparency Data Monthly Statistics, available at: https://otctransparency.finra.org/otctransparency/OtcData otctransparency/OtcData; and FINRA ATS Transparency Data Monthly Statistics, available at: https://otctransparency.finra.org/otctransparency/AtsBlocksDownload. This analysis uses data from prior to the
  implementation of the MDI Rules and specific numbers reported may be different following the implementation of
  the MDI Rules. See supra note 767 and section VII.C.1.(d)(2).

    These market centers, among other things, match traders with
counterparties, provide a framework for price negotiation and provide
liquidity to those seeking to trade, to supply investors with execution
services at efficient prices. Market centers' primary customers are the
broker-dealers that route their own orders or their customers' orders
for execution at the trading center, and market centers compete with
each other for these customers on a number of dimensions, including
execution quality.
    Broker-dealers may face switching costs from changing the primary
trading venues to which they route orders. For example, the extent to
which broker-dealers may have long-term contractual arrangements to
route orders to specific market centers would hamper their ability to
switch trading venue. The common practice across national securities
exchanges of setting fee and rebate schedules where specific tiers are
determined by execution volume \771\ may also make it difficult of
broker-dealers to transfer order flow between market centers. Volume-
based tiering gives broker-dealers an incentive to concentrate orders
on a given exchange, not because that exchange may offer the best
execution quality but because doing so can allow a broker-dealer to
execute sufficient volume on the exchange to qualify for a better tier
and receive a lower fee or higher rebate. In addition, for national
securities exchanges, upfront connectivity fees associated with
establishing a connection to a new exchange could also discourage
switching.
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    \771\ Some national securities exchanges typically currently use
volume calculated on a monthly basis to determine the applicable
threshold or tier rate. See, e.g., fee schedules of NASDAQ PSX,
available at https://listingcenter.nasdaq.com/rulebook/phlx/rules/Phlx%20Equity%207 (as of July 2022) (calculating fees based on
``average daily volume during the month''); and Cboe EDGA, EDGA
Equities Fee Schedules, available at https://www.cboe.com/us/equities/membership/fee_schedule/edga/ (as of Apr. 1, 2022)
(calculating fees based on ``average daily volume'' and ``daily
volume'' on a monthly basis).
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    While national securities exchanges cater to a broader spectrum of
investors, ATSs and OTC market makers, including wholesalers, tend to
focus more on providing trading services for either institutional or
individual investor order flow. For example, an analysis of retail
brokers' routing practices showed that a group of six wholesalers
handled more than 87% of the customer orders of retail brokers in Q1
2022.\772\ Meanwhile, SDPs are mainly used for institutional orders, to
avoid exposure to potentially more informed order flow on other trading
venues.\773\
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    \772\ See supra note 614 for more details about this analysis.
    \773\ See, e.g., Yashar H. Barardehi, et al., Internalized
Retail Order Imbalances and Institutional Liquidity Demand (working
paper revised May 23, 2022), available at https://ssrn.com/abstract=3966059 (retrieved from SSRN Elsevier database).
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(2) Competition Between Trading Venues on the Basis of Execution
Quality
    Trading venues compete with one another on the basis of the
execution quality that they offer, as well as on the basis of other
potential factors.\774\ As discussed above, Rule 605 reports are
currently a useful proxy that investors and their broker-dealers can
use to assess and compare the execution quality that they can expect to
receive across market centers,\775\ and there is evidence that broker-
dealers factor in information about the execution quality of market
centers from Rule 605 reports when making their order routing
decisions. One academic study attributes a significant decline in
effective and quoted spreads following the implementation of Rule 605
to an increase in competition between market centers, who improved the
execution quality that they offered in order to attract more order
flow.\776\ Market centers may seek to improve their competitive
position on the basis of execution quality by, for example, investing
in the speed and quality of their execution technology.
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    \774\ For example, national securities exchanges may adjust fees
and rebates to incentivize broker-dealers to route more order flow
to them. The use of liquidity rebates have also allowed national
securities exchanges to compete with off-exchange market centers for
order flow by making it more expensive to offer price improvement
over the displayed NBBO. See Transaction Fee Pilot for NMS Stocks,
84 FR 5202 (Feb. 20, 2019) at 5255.
    \775\ See supra section VII.C.1.(a).
    \776\ See Zhao & Chung.
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    Market centers have less of an incentive to compete and innovate on
execution quality to the extent that broker-dealers route orders for
reasons other than execution quality. As discussed above, if
information asymmetries, such as those resulting from insufficient
public information about broker-dealer execution quality, prevent
investors from observing differences in execution quality across
broker-dealers, this would limit the extent to which broker-dealers
would need to compete on the basis of execution quality.\777\ Market
centers also have less of an incentive to compete on the basis of
execution quality to the extent that broker-dealers and other market
participants are less able to use Rule 605 reports to compare execution
quality across market centers, for example, as a result of erosions to
the information content of Rule 605 statistics due to changes in market
conditions,\778\ or to the extent that Rule

605 does not include some relevant order sizes or types.\779\
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    \777\ See supra section VII.C.3.(a)(2).
    \778\ For example, market centers may be less incentivized to
compete on the basis of execution speed to the extent that, as a
result of rapid increases in the speed of trading, market
participants are less able to use time-to-execution measures from
Rule 605 reports to compare across market centers. See supra section
VII.C.2.(c)(4) for further discussion.
    \779\ For example, market centers may be less likely to compete
on the basis of execution quality for orders of less than 100
shares, since these orders are not required to be included in Rule
605 reports. See supra section VII.C.2.(b)(1)(b) for further
discussion.
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D. Economic Effects

    The proposed amendments modifying the reporting requirements under
Rule 605 may result in numerous beneficial economic effects. These
economic effects would mainly derive from improvements in the
transparency of execution quality of broker-dealers and market centers,
which would promote competition among these reporting entities on the
basis on execution quality. However, the proposed amendments to Rule
605 may also result in initial and ongoing compliance costs to
reporting entities.
    As discussed above, this section measures the economic effects of
the proposed amendments relative to a regulatory baseline that includes
the implementation of the MDI Rules.\780\ Furthermore, this section
reflects the Commission's assessment of the anticipated economic
effects, including potentially countervailing or confounding economic
effects from the MDI Rules.\781\ However, given that the MDI Rules have
not yet been implemented, they have not affected market practice and
therefore data that would be required for a comprehensive quantitative
analysis of the economic effects that includes the effects of the MDI
Rules is not available. It is possible that the economic effects
relative to the baseline could be different once the MDI Rules are
implemented. Where implementation of the above-described MDI Rules may
affect certain numbers, the description of the economic effects below
notes those effects.
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    \780\ See supra section VII.C.1.(d).
    \781\ See supra section VII.C.1.(d)(2) for a discussion of the
Commission's anticipated economic effects of the MDI Rules as stated
in the MDI Adopting Release.
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1. Benefits
    The Commission believes that the proposed amendments would promote
increased transparency of order execution quality as a result of the
expansion and modernization of Rule 605 disclosure requirements, as
well as a requirement for reporting entities to prepare summary
reports, which would improve market participants' ability to use Rule
605 reports and the information contained therein to compare execution
quality across reporting entities. This in turn would lead to increased
competition between reporting entities on the basis of execution
quality, leading to improvements in the execution quality received by
investors as competition between reporting entities would be create
incentives to offer better execution quality in order to attract and
retain customers and order flow.
(a) Increase in Transparency and Access to Information About Execution
Quality
    The Commission believes that the proposed amendments would promote
increased transparency of order execution quality, particularly for
larger broker-dealers who were not previously required to disclose
execution quality information under Rule 605, but also for all
reporting entities, whose execution quality information would be more
relevant and easier to access as a result of improvements to existing
Rule 605 disclosure requirements.
(1) Expanding the Scope of Reporting Entities
(a) Expanding Requirements for Larger Broker-Dealers
    The proposed amendment expanding the scope of Rule 605 reporting
entities to include larger broker-dealers \782\ would increase
transparency into the differences in execution quality achieved by
these broker-dealers when they route customer orders to execution
venues.\783\ Broker-dealers that route customer orders have many
choices about where to route customer orders for execution,\784\ and
their routing decisions affect the execution quality that their
customers' orders receive.\785\ To ensure that they are directing their
orders to the broker-dealer(s) that are able to achieve better
execution quality, investors, along with other market participants,
have a vested interest in their ability to accurately assess the
execution quality that their broker-dealers are able to achieve.
However, in the current regulatory environment, the ability of some
customers to assess the execution quality that their broker-dealers are
providing for their held orders may be limited.\786\
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    \782\ See supra section III.A for further discussion of the
proposed amendments related to the expansion of Rule 605 reporting
entities to include larger broker-dealers.
    \783\ The EMSAC and commenters generally supported expanding the
Rule's scope beyond market centers, including to broker-dealers. See
supra notes 103-119 and accompanying text. The Commission believes
that these effects would principally accrue to larger broker-
dealers, who would be required to prepare Rule 605 reports, but may
spill over to effect smaller broker-dealers as well. See discussion
in infra section VII.D.1.(d)(1).
    \784\ See supra section VII.C.3.(b)(1), discussing fragmentation
in the market for trading services for NMS stocks.
    \785\ See, e.g., supra note 529 and accompanying text,
describing a recent academic working paper finding significant
variations in execution quality across broker-dealers.
    \786\ See supra section VII.C.2.(a)(1) for a discussion of
limitations to investors' abilities to use Rule 606 and Rule 605
reports to estimate the execution quality achieved by broker-
dealers. Note that institutional investors may have access to
alternative sources of information about execution quality. See
supra section VII.C.1.(c)(2) for a discussion.
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    As a result of the proposed amendments, customers of these broker
dealers, along with other market participants, would no longer need to
make inferences about these broker-dealers' execution quality based on
broker-dealer routing information from Rule 606 data combined with
market centers' execution quality information from Rule 605 data, but
would have access to direct information about the aggregate execution
quality achieved by these broker-dealers.\787\ Customers could then use
this information to compare across broker-dealers and select those
broker-dealers offering better execution quality. Furthermore, combined
with information about broker-dealers' payment relationships with
execution venues in quarterly reports prepared pursuant to Rule
606(a)(1), information about the aggregate execution quality obtained
by larger broker-dealers that are in the business of routing customer
orders would give market participants and other interested parties
access to key information that would facilitate their ability to
evaluate how these payment relationships may affect execution quality.
---------------------------------------------------------------------------

    \787\ This effect would be enhanced by the requirement that
broker-dealers publish Rule 605 reports for their broker-dealer
activities separately from activities related to the market
center(s) that they may operate, which would allow investors to
access execution quality information that is exclusively related to
the firm's broker-dealer operations. See supra note 182 and
accompanying text.
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    Under the proposed amendments, larger broker-dealers would be
required to categorize the execution quality information required by
Rule 605 using the same categories that market centers would be
required to use, including by individual security, different types of
orders, and different order sizes. As with market centers, a particular
broker-dealer's order flow may be made up of a different mixture of
securities, order types, and order sizes, which may impact or constrain
that broker-dealer's

overall execution quality level.\788\ For example, Figure 14, which
uses a week of CAT data \789\ to break down broker-dealer order flow
into different order types, shows that broker-dealers indeed handle a
variety of order types, including both marketable and non-marketable
orders, for both their individual and institutional investor customers.
Giving market participants access to this information in Rule 605
reports would ensure that they are able to control for these
differences in order flow characteristics when assessing and comparing
execution quality information across broker-dealers.
---------------------------------------------------------------------------

    \788\ See supra note 513 for an example of how differences in
order flow characteristics may impact inferences about execution
quality.
    \789\ See supra note 609 for dataset description.
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Figure 14: Broker-Dealer Order Volume by Order Type, January 3-7, 2022
[GRAPHIC] [TIFF OMITTED] TP20JA23.014

    The proposed amendment for larger broker-dealers to report both the
number of shares executed at the receiving broker-dealer and the number
of shares executed at any other venue \790\ would ensure that Rule 605
reports capture the execution quality of all orders that larger broker-
dealers receive for execution as part of their customer-facing broker-
dealer function. The majority of executions resulting from a firm's
broker-dealer operations would likely be categorized as away-executed
shares in the Rule 605 reports associated with its broker-dealer
operations.\791\ While these shares would not be categorized as being
directly executed by the broker-dealer, it is likely that market
participants understand that execution quality can depend significantly
on the broker-dealers' order handling and routing practices.
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    \790\ See 17 CFR 242.605(a)(1)(i)(D) and (E). As discussed
herein, the Commission is proposing to modify Rule 605(a)(1)(i)(D)
to also cover the number of shares executed at the receiving broker
or dealer. See supra note 155 and accompanying text.
    \791\ To the extent that a broker-dealer also acts as a market
center, any executions that it handles would be required to be
published in the Rule 605 report(s) that it files in its capacity as
a market center.
---------------------------------------------------------------------------

    The proposed amendments would also require larger broker-dealers to
report the same execution quality information as market centers,
including information about execution prices, execution speeds, and
fill rates,\792\ as well as, as a result of the proposed amendments,
information about size improvement.\793\ The Commission acknowledges
that there are certain ways in which broker-dealers may systematically
differ from market centers in terms of their execution quality
statistics; for example, due to their need to reroute orders that they
receive for execution, broker-dealers are likely to have a longer
execution time as measured from the time of order receipt, as compared
to market centers who can execute orders immediately without the need
to reroute. However, these differences are generally well-known to
market participants, who would be able to account for these differences
in assessing execution quality. Furthermore, it is unlikely that market
participants would use information in Rule 605 reports to compare
broker-dealers to market centers, as information about the execution
quality of these two types of reporting entities is useful to different
market participants for fundamentally different purposes. In terms of
the principal-agent problems described in the Market Failure
section,\794\ information about execution quality for broker-dealers
solves a different principal-agent problem than information about
execution quality for market centers. Broker-dealers' Rule 605 reports
would be more likely to be used by broker-dealers' customers to compare
execution quality across broker-dealers to alleviate the principal-
agent problem that exists between broker-dealers and their customers.
In contrast, market

centers' Rule 605 reports would continue to be more useful for broker-
dealers to compare execution quality across market centers to alleviate
the principal-agent problem that exists between broker-dealers and the
market centers to which they route their customers' orders.
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    \792\ See supra section VII.C.1.(a) for a discussion of the
economic significance of the execution quality information currently
required by Rule 605 to be disclosed by market centers.
    \793\ See proposed Rule 605(a)(1)(i)(F) and discussion in supra
section IV.B.4.(e).
    \794\ See supra section VII.B.
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    The Commission is mindful that Rule 605's execution quality reports
contain a large volume of statistical data, and as a result it may be
difficult for individual investors to review and digest the reports. By
requiring larger brokers-dealers to report stock-by-stock order
execution information in a uniform manner, the current proposal would
make it possible for market participants and other interested parties
to make their own determinations about how to group stocks or orders
when comparing execution quality across broker-dealers. Requiring
larger broker-dealers to produce more detailed execution quality data
would also help ameliorate potential concerns about overly general
statistics, or about the specific categorization of orders and
selection of metrics in the summary reports, by allowing market
participants and other interested parties to conduct their own analysis
based on alternative categorizations of the underlying data. Should
certain market participants not have the means to directly analyze the
detailed statistics,\795\ independent analysts, consultants, broker-