Exceptional and accessible legal representation across Kentucky and Nationwide

Exceptional and accessible legal representation across Kentucky and Nationwide

EXCEPTIONAL AND ACCESSIBLE LEGAL REPRESENTATION ACROSS KENTUCKY AND NATIONWIDE

Best execution responsibilities of retail brokers

| Jun 17, 2021 | FINRA, Representing Investors, Securities Law And Litigation |

Many individuals use low- or no-commission brokers to purchase and sell their investments in various securities. While this seems like a good deal – and it probably is – federal regulators require discount brokers to diligently monitor whether their customers’ transactions are executed in the best markets for the type of securities bought or sold.

Potential pitfalls of order flow arrangements

Without major commissions, a broker-dealer must make money in other ways. One way is to sell batches of its customers’ trades to large institutions (such as market makers, exchanges or wholesale operations) that use sophisticated automated programs to execute those transactions in particular markets on behalf of the individual investors, but as part of their larger-scale operations.

The broker-dealer makes money through the order flow arrangements it has with large wholesalers in which it “sells” its customer’s transactions to the wholesaler for execution on behalf of the retail customer. This puts a broker-dealer in a position of self-interest because it may seek the highest price for its customers’ order flow – which is a financial advantage to the broker but not necessarily to its retail investors.

A focus on broker-dealer profits alone could send investor transactions for execution to an entity that does not execute those transactions in the interests of the investors. For example, it may sell or buy securities in a market that is not as lucrative for the investor as other markets would be.

Regulatory investor protections

The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) protect retail investors by imposing best execution rules and other practices that require:

  • Broker-dealers that sell customer trades to third parties to complete to use reasonable diligence to determine which market offers the best price to the customer and see that the transaction happens there; in an order flow arrangement, that means to satisfy the best execution requirement, the broker-dealer must either review every order or conduct reviews at least each quarter by type of security and order type
  • Broker-dealers to disclose when they use order flow arrangements for which they receive money
  • Broker-dealers to identify the wholesalers involved and the prices they pay to the broker-dealers for order flow arrangements
  • Broker-dealers to provide quarterly reports for client review about these arrangements, including all major aspects of the relationships with the execution venues to reveal any conflicts of interest
  • Broker-dealers to use reasonable diligence to send their customers’ orders to venues that will use best transactional execution standards
  • Broker-dealers to create written supervisory procedures (WSPs) that establish internal practices that continuously and diligently monitor the quality of wholesaler execution of client transactions by comparing bid and ask levels in competing markets
  • And other requirements

Recent example of allegations that a broker violated the duty of best execution of customer orders

FINRA settled charges of rule violations in March 2021 against a member broker-dealer. The settlement letter provides detailed descriptions of the kinds of allegations that may come up when best execution and order flow arrangement issues are involved.

Any person with questions or concerns about the best execution responsibilities of its broker-dealer should consult a securities attorney to understand the legal options.