MasteringExecution

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DearMichaelLewis:IfYouDontUnderstandSomething,PleaseAskfor
Assistance
DavidWeisberger,RegOneSolutions
23March2015

Executionqualityforindividualinvestorsisasgoodasithaseverbeen,arguesRegOnesDavidWeisberger,who
publiclychallengesMr.Lewisoranyothercriticwhoassertsthatretailinvestorsarebeingtakenadvantage.But,
Weisbergeracknowledges,thereareconflictsofinterestintradingonbehalfofinstitutionalinvestors,andthose
tradingpracticesarestillrelativelyopaque.
IwouldliketoissueapublicchallengetoMr.Lewis
InresponsetoyetanotherroundofhalftruthsandinnuendosspokenbyMichaelLewis,BartChilton,formercommissioneroftheCFTC
andcurrentspokespersonfortheModernMarketsAlliance,calledMr.LewissclaimsAbiglie.WhileIagreethatMr.Lewis,inboth
FlashBoysandhisrecentpieceinVanityFair,fabricatesclaimsabouthowretailinvestorsaremistreated,Mr.Chiltonisonlyhalfright:
Heiscorrectthatexecutionqualityforindividualinvestorsisasgoodasithaseverbeenunfortunately,hedoesnotaddresssomeofthe
otherclaimsmadeabouttheequitymarket.Sadly,thereareconflictsofinterestintradingonbehalfofinstitutionalinvestorsandthose
tradingpracticesarestillrelativelyopaque.
First,letsexaminewhatMr.Chiltongetscorrect.WhileSECRule605iscertainlyinneedofanoverhaul,ithasclearlyprovidedmassive
benefitstoretailinvestors.Statisticsshowthatretailinvestorswhodemandliquidityfromthemarket(usingmarketormarketablelimit
orders)haveNEVERhaditbetter.ThetopretailbrokeragefirmsusethedisclosuresrequiredbyRule605andrelatedmetricsadoptedby
theindustrytopromotefiercecompetitionamongwholesalemarketmakers.Theresulthasbeenincredibleretailinvestorsreceivedmore
than$600millionindirectpriceimprovementfromwholesalersin2014alone,upfromroughly$100millionin2004.
ThesuperiortreatmentofretailorderswasconfirmedinarecentarticlewritteninBarronsbyawardwinningjournalistWilliamAlpert
(WhoMakesMoneyonYourStockTrades).Whileithasreceiveditsshareofcriticismbyacadreofuninformedcritics,Mr.Alpert
thoroughlyresearchedthisarticleanddevelopedhisownstatisticalprogramstoanalyzeactualexecutiondata.TheyareavailableviaOpen

SourceonGitHubforanyonethatwantstoimprovethem,criticizethemorsimplyusethem.Inparticular,hisanalysisprovesthatprice
improvementpersharehasincreasedsubstantiallyandiscertainlynotdeminimus,asthecriticsclaim.
Thefollowingchartshowsthebenefittoretailinvestorsdirectly.Itshowsthetrendofthemostusedmetricofexecutionqualityeffective
spreaddividedbyquotedspreadforacrosssectionofretailinvestorssince2006.Thismetricshowsthatforallorders,regardlessofsize,
theaverageretailinvestorinoursampleusedtopayroughly15%morethanthebidofferspreadtocompletetrades.Today,however,the
sameinvestorpaysmorethan15%LESSthanthespread.

Source:RegOneSolutions,copyright2015
WhatisNOTobviousaboutthesenumbersiswhyithashappened.Thefactisthatretailinvestorshavelittletofearfromtheadvanceof
technology,becauseitworkstotheiradvantage.Thetopwholesalemarketmakersarebasedonthesametechnologyplatformsoftenderided
bycritics.Thesefirmsemploystateofthearttechnologyasacompetitivetooltoprovidebetterexecutionsfortheirretailbrokerageclients.
Whilewearenotclaimingthatmarketmakersarealtruistic,wearemakingthepointthatretailinvestorsdirectlybenefitfromthe
technologytheyemploy.Tobeclear,thestatisticsthatRegOnegeneratesthatprovethebenefitstoretailinvestorscannotberigged(assome
uneducatedcriticshavefalselyasserted).AtRegOnewebaseourexecutionanalysisonthelastquoteofthetimeintervalbeforethesefirms
receiveeachorder.Thismakesitimpossibletomanipulatethepriceimprovementstats.
Inordertounderscorethispoint,IwouldliketoissueapublicchallengetoMr.Lewisoranyothercriticwhoassertsthatretailinvestorsare
beingtakenadvantageof.Inparticular,Ichallengethemtonameaparticularfirmwhotheyarewillingtoassertfrontrunsindividual
investorsafterthebuttonispushed.IfMr.Lewisiswillingtonameanyofthetopsixmarketmakers,asidentifiedbyRule605reports,as

doingthis,IwillhappilyappearonCNBCwithhimtoprovidestatisticalevidenceofhisduplicity.
Now,backtoMr.Chilton.Whathegetswrongisthatthereareconflictsofinterestandthereistoomuchopacityinthemarketfor
institutionalinvestors.TheconflictsofinterestIamreferringtowerespelledoutinmyrecentcommentary,DirtyRottenSecrets.They
occurwhenbrokerdealersmakedesignchoicesintheiralgorithmsorsmartorderrouters,basedmoreonthedifferentfeeorrebatestructure
ofvenues,insteadofthepredictedexecutionprobabilityormarketimpactofdifferentroutingchoices.Thefactthattheseroutingchoices
areoftenhazyistheotherproblem.TheresultsofNasdaqsrecentexperimenttotestloweraccessfeesandrebatesforahandfulofstocks
bearsthisout:Nasdaqlost2.9%marketshareasrouterssoughtmorefavorablerebatesatothervenues.
[Related:MarketStructureReforms:BanningMakerTakerWontEliminateBrokerConflicts]
Rule605,whichisdesignedtoshowtheexecutionqualityofallmarketcenters,excludesmorethan65%ofexecutedvolume.Market
centers,includingthoserunbythelargebrokerdealers,areallowedtoexcludeallthechildordersthatcanbelinkedtodiscretionary
institutionalorders.Thus,allordersroutedbyalgorithms,onbehalfoflargerordersorinstitutionalclients,canpotentiallybeexcludedfrom
theexecutionqualityreportingofRule605.Rule606,whichisdesignedtoprovidedisclosureonorderroutingpractices,excludesa
majorityofallroutedordersfromreporting.Whilethatstatementislikelysurprisingtomanyreaders,ordersthatarerouted,butnot
executed,arenotsubjecttoreporting.
Toillustratewhythisisproblematic,Ilookedatthemostrecentmonthof605dataandcalculatedtheratioofroutedsharestoexecuted
shares.Forthissampleoforders,whichgenerallyhasahigherpercentageofexecutionstoordersthantheinstitutionalorderflowthatis
excludedfromRule605,theratioisroughly7:1.Thatimpliesthatmorethan85%oforderroutingisnotdisclosedbyRule606.Further,
Rule606doesnotrequiredisclosureofeitherfeesorexecutionqualityanddoesnotrequireanysegmentationofordertypesutilized.Lastly,
Rule606doesnotrequirestockexchangestoreport,despitethefactthattheyareamongthelargestorderroutersinthemarketplace.
Mycontentionisthattheseexclusionshavecontributedheavilytotheclimateofmistrustamonginstitutionalinvestorsandcriticsofmodern
markets.Idonotthinkthatitisatallsurprisingthatretailinvestorshaveseendramaticimprovementsintheirexecutionquality,whilemany
institutionalinvestorsclaimthattheyhavenot.Whileitisnotatallclearwheretoplaceblameontheperceptionsofmarketproblems,it
seemsquiteobviousthatimprovingtransparency,byeliminatingthegapsmentionedhere,wouldbeagoodstart.
IfirmlybelievethatfixingbothRule605and606shouldbeapriorityfortheSEC.
Ihavepointedthisoutseveraltimesinmycommentariesandnumerousothershavemadethesamepoint.Earlierthisyearapetitionwiththe
SECwasfiledbyBATS,makingthissamepoint.Iftheexemptionsintheruleswereeliminated,thereportingcategoriesexpanded,andthe
relevantfees,rebatesandexecutionstatisticsweredisclosed,institutionswouldstarttogainsomeoftheadvantagesthatdisclosurehas
providedtoretailinvestors.
[Related:BestExTransparency:AreWeLookingintheRightPlace?]

Thesechangeswouldalsoenablefirms,suchasours,tohelpparticipantsmakesenseofthedataanddevelopactionableplansforimproving
theirexecutionquality.Itwouldalsofocusthemarketmicrostructureconversationonmeaningfuldataandanalysisratherthaninnuendo
andhalftruthsbyuninformedcritics.
Thebottomlineisthattransparency,enabledbytechnology,isthebestpossiblesolution.IbelievethattheSECandFINRAunderstandthis,
soweshouldhelpthemfocustheirrulemakingtowardencouragingmoretransparency,insteadofrespondingtovariouslobbyingor
legislativeeffortstopushanticompetitiverules.
Inthisregard,IagreewholeheartedlywithMr.Chilton.
ThiscommentaryoriginallywaspublishedontheRegOnewebsite.

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