The SEC is Making Changes in 2023

In mid-December, the U.S. Securities and Exchange Commission unanimously adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934. The amendment imposes new disclosures and trading restrictions, including cooling off periods, aimed to curb insider trading.

The Commission also approved four proposals aimed at equity market reform. Two are particularly notable, somewhat controversial, and being challenged by some of the Commissioners.

Regulation Best Execution

The first reform being debated is Regulation Best Execution, which will require broker-dealers to establish written policies for executing orders in the best interest of their customers. According to the SEC, "[t]he duty of best execution requires a broker-dealer to execute customers' trades at the most favorable terms reasonably available under the circumstances." The Financial Industry Regulatory Authority, Inc. ("FINRA), a national securities organization, and the Municipal Securities Rulemaking Board ("MSRB") already have rules directly addressing the duty of best execution. While the SEC has made statements concerning the duty of best execution over the years, it now deems it relevant to officially propose its own best execution requirements.

One concern addressed by the new rule is conflicts of interest created by the execution of retail customer orders by broker-dealers. Orders handling conflicts of interest include payment for order flow, principal trading, and routing customers order to affiliates.

If this reform passes, among other things, brokers will be required to document arrangements they make with wholesalers through a practice known as "payment for order flow." SEC Chair Gary Gensler believes there is a "conflict of interest" tied to the practice, which trading apps lean on to provide fee-free stock trading for its users. However, "[z]ero commission doesn't mean zero cost," Gensler said, describing payment for order flow as an "economic rent" imposed by brokers on retail investors.

The Commissioners challenging the rule question the need for an additional best execution rule in light of the pre-existing FINRA and MSRB rules.

Order Competition Rule

Another reform at issue is the Order Competition Rule. The SEC designed the Order Competition Rule "to promote a more competitive, transparent, and efficient market structure for NMS [National Market System] stocks, with resulting benefits to investors."

Implementation of this rule would in effect create an auction system for access to certain individual buy or sell orders. According to the SEC, 90% of those orders are currently routed through a small group of wholesalers, six of which collectively paid retail brokers like Robinhood $235 million for access to their customers' stock order flow in the first quarter of 2022. "The Commission believes that customers would benefit from considerations by these retail broker-dealers of whether other markets may provide customer orders, or a portion of those orders, with potentially better executions than wholesalers." The agency said creating an auction system could add $1.5 billion annually into investors' pockets.

Certain Commissioners challenge this rule on the basis that it "threatens to create disorder in the capital markets." According to Commissioner Hester Pierce, "imposing extra steps before an order can be filled could create 'unintended consequences.'"

The public has until at least March 31, 2023, to comment on the proposals before the commission discusses potential adoption.

The SEC's Limited Reach

We applaud the SEC's continued commitment to protect investors who rely on our markets to secure their financial futures. However, the SEC and other governmental agencies can only take certain action on behalf of investors. Certain remedies must be achieved through private litigation. If you ever have a concern regarding the impact of corporate malfeasance on your investments, please contact Robbins LLP for a free evaluation of your legal options.