The Equity Market Structure Advisory Committee of the Securities and Exchange Commission (SEC) will be holding its first meeting starting at 9:30 am Eastern Time on May 13, 2015 to discuss the impact of SEC Rule 611 of Regulation NMS — the SEC’s “order protection” or “trade-through” Rule — on US equity market structure.
The SEC’s Division of Trading and Markets has prepared, and made publicly available, a background memorandum on the history and effects of Rule 611.
Rule 611 was adopted in 2005 as part of Regulation NMS and requires “trading centers” to implement policies and procedures that are reasonably designed to prevent “trade-throughs” on a trading center of “protected quotations” not covered by specific exceptions. Trading centers broadly include all venues in the US equity market trading structure, including, exchanges, alternative trading systems — both dark pools and electronic crossing networks (ECNs), off-exchange market-makers and other broker-dealers that execute trades internally, whether as principal or agent.
The primary goals of Rule 611 were to promote the use of non-marketable limit orders as a way of obtaining the best price and to minimize the extent to which market and limit orders could be executed away from the best price.
A trade-through is defined as a purchase or sale during regular trading hours at a price that is lower than a protected bid or higher than a protected offer.
Protected bids and offers are the best quotes on the 11 US exchanges that presently trade NMS stocks and FINRA’s Alternative Display Facility (ADF) that are disseminated through the US consolidated market data feeds and can be immediately and automatically executed against. It is therefore a protection only for the “top” of the market and not for the depth of book.
While not mandating the routing of orders to trading centers displaying the best price, Rule 611 facilitates compliance by permitting “intermarket sweep orders” (ISOs) that allow immediate executions at any price or size as long as ISOs are routed to execute against any better-priced protected quotations in other trading centers.
The SEC Staff Report discusses four major critiques of Rule 611 advanced by some commentators to aid the Committee in its discussions:
- That the Rule has contributed to excessive fragmentation, increasing market complexity and connectivity costs for market participants
- That it has promoted dark trading by constraining competition on lit markets to factors such as speed, fees, and order types, rather than liquidity and stability
- Institutional investors have been harmed by forcing them to access smaller-sized quotations and thereby signaling their trading intentions to short-term proprietary traders
- The displaying of limited orders has not been rewarded as intended when the Rule was adopted
Tomorrow’s meeting will be webcast and can viewed live or in archived form through the SEC’s web site.