Commentary

Elaine Wah

Modern Markets, Modern Metrics - A Blog By IEX

In this blog by IEX's Elaine Wah, the newest public exchange looks to refute public claims that the metrics it uses are designed to inflate its own volume numbers and mislead people.

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August 31, 2000

Big Brother Wants More Dealer Disclosure

By William Hoffman

The SEC has new plans to make dealers disclose more information about their execution policies.

Proposed Rule 11Ac1-5 would require exchange specialists, over-the-counter market makers, electronic communications networks and others to issue monthly electronic public reports showing uniform statistical measures of execution quality for each stock transaction.

These measures include price fluctuation, execution speed, and limit order fill rates. Proposed Rule 11Ac1-6 would mandate that brokers that route customers' orders disclose on free Internet sites quarterly reports that describe their order routing practices. Brokers would also have to disclose any material relationships with the market center, such as internalization or payment for order flow.

Useful Benefit

New York-based securities industry attorney Neil A. Sussman noted that the execution-quality statistics would be aggregated on a stock-by-stock basis and not on a trade-by-trade basis. That would be more useful to investors. And there are no plans to issue a user's manual that could educate investors about the data's meaning, Sussman noted.

Sussman, who works mainly for retail clients, further criticized the order flow regulation. Brokers won't be required to disclose their rationale for establishing relationships with market centers, only that such relationships exist. And the quantity of compensation, which has never been disclosed to the general public (mark-ups, mark-downs, sales credits for OTC stocks) will remain private, he said.

Lee Korins, chief executive of the Security Traders Association, said the second rule suggests the SEC was giving a back-handed blessing to the controversial practice of payment for order flow, since disclosure procedures imply prohibition may be off the table for now.

Prof. Ralph Estes, professor emeritus of accounting at the Kogod School of Business at American University in Washington, charged that the effectiveness of both rules is compromised by the lack of true financial auditor independence. That was an issue under consideration at the SEC.

Estes said auditors are commonly asked to pass sensitive, even damaging judgments on the financial integrity of clients. Since there are no firewalls at consulting firms separating accountants from account managers, the pressure is on to compile the best financial picture. That picture may be at odds with an investor's interest in accurate information.

Moreover, Estes said, accountants are called upon not only to prepare clients' taxes, but to estimate the cost of settling if the Internal Revenue Service disputes a return. That's an intolerable self-review for scrupulous accountants, he added. Estes said the federal government must establish an independent agency, empowered to levy fees on publicly-traded companies and to assign auditors to review their financial statistics. Until then, he said, every calculation traders make in assessing stock performance will be flawed, and every disclosure of financial information will be skewed.

Saul S. Cohen, partner at the New York law firm of Proskauer Rose, LLP, and an attorney for the Electronic Traders Association, said the new rules "won't be a significant burden in an age of technology." Sussman agreed, saying brokers he's talked with call the proposals a nuisance rather than a burden. Cohen added that the newly disclosed data could even be a boon for competitive firms, as they selectively highlight their own favorable reports against those of poor performers.