The Securities and Exchange Commission (SEC) is proposing new rules under the Securities Exchange Act of 1934 relating to a broker-dealer’s duty of best execution, to “enhance the existing regulatory framework concerning the duty of best execution by requiring detailed policies and procedures for all broker-dealers and more robust policies and procedures for broker-dealers engaging in certain conflicted transactions with retail customers, as well as related review and documentation requirements.”
Commissioner Hester Peirce, said, “We are proposing to supplant brokers’ judgment with our own step-by-step guide to achieving best execution. In the process, we are drawing sweeping conclusions about execution quality in equity markets, options markets, corporate bond markets, municipal markets, and crypto markets. Although I could have supported a principles-based Commission best-execution rule proposal, I cannot support this proposal, which is unduly prescriptive and seems less concerned about whether customers actually get best execution than if brokers implement a checklist that the Commission itself is not confident will help brokers achieve even better—much less best—execution.”
The Financial Industry Regulatory Authority (FINRA), a national securities association, and the Municipal Securities Rulemaking Board (MSRB) currently have rules and guidance directly addressing the duty of best execution. The Commission has made statements concerning the duty over the years, but has never itself established a rule addressing best execution.
Commissioner Mark Uyeda said, “An obvious issue with this proposal is that there are already existing best execution regulatory regimes, which appear to be working well. This rule proposal would add a third best execution regime layered on top of the ones already imposed by FINRA and the MSRB. Do we need another one?
While the SEC says it believes the existing regulatory framework concerning the duty of best execution has helped broker-dealers fulfill their duty to their customers, it also believes this regulatory framework can be made more effective. While FINRA and the MSRB have established best execution rules and provided guidance on how broker-dealers should achieve best execution in a variety of contexts, and generally require broker-dealers to have procedures for compliance with relevant laws and rules, the Commission believes it is appropriate to propose its own comprehensive and detailed best execution requirements.
The SEC says it understands that, currently, broker-dealers’ best execution policies and procedures, and the documentation relating to their best execution practices, may vary and that customers would benefit from “consistently robust” best execution practices by broker-dealers, plus the execution of retail customer orders by broker-dealers that have certain order handling conflicts of interest warrants heightened attention by those broker-dealers.
Regulation Best Execution would establish a “best execution standard” for broker-dealers, specifically requiring them to establish, maintain, and enforce written policies and procedures reasonably designed to comply with that best execution standard.
Those policies and procedures would be required to address:
(1) how the broker-dealer will comply with the proposed standard of best execution, including by identifying material potential liquidity sources, incorporating material potential liquidity sources into its order handling practices, and ensuring that the broker-dealer can efficiently access each source, and;
(2) how the broker-dealer will determine the best market for customer orders received, including by assessing reasonably accessible and timely pricing information and opportunities for price improvement.
In addition, for retail customer transactions that present conflicts of interest, such as payment for order flow or internalisation, that could create incentives for a broker-dealer to be less diligent in its search for better executions and potentially result in broker-dealers not providing best execution to customer orders, proposed Regulation Best Execution would require the broker-dealer’s policies and procedures to address how it will comply with the best execution standard in light of such conflicts, including how it would assess a broader range of markets than it would for non-conflicted transactions.
Proposed Regulation Best Execution would also require broker-dealers to document their compliance with the best execution standard and the basis for their determinations that best execution would be achieved through conflicted transactions.
The rules would require broker-dealers to review the execution quality of their customer orders at least quarterly, compare it with the execution quality that might have been obtained from other markets, and revise their best execution policies and procedures accordingly. It would exempt from specified requirements under the proposed rules an introducing broker as defined in the proposed rules that establishes, maintains, and enforces policies and procedures that require it to regularly review the execution quality obtained from its executing broker, compares that execution quality with the execution quality it might have obtained from other executing brokers, and revises its order handling practices accordingly.
Finally, it would require broker-dealers to review and assess the overall effectiveness of their best execution policies and procedures, including their order handling practices, on at least an annual basis, and prepare a report detailing the results of such review and assessment that would be presented to the broker-dealer’s board of directors (or equivalent governing body.
“Institutional customers arguably do not need the protection of a best-execution rule, particularly one as prescriptive as this proposal,” argued Peirce. “The proposed rule makes price the primary objective of the broker. Institutional investors may have other important objectives, such as speed and minimising the effect on price. The rule makes it hard for institutional brokers to tailor best execution to a customer’s objectives.”
©Markets Media Europe 2022
