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Finra to probe broker conflicts when exchanges offer rebates

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(Bloomberg) — Some brokers might not be getting the best prices for clients when they send stock orders to exchanges that offer rebates, regulators said in an outline of annual oversight priorities.

Recent brokerage inspections found that some firms don’t have active “best-execution committees” or other supervisors in place to ensure that clients get the best price as securities rules require, the Financial Industry Regulatory Authority said today in a letter about its 2015 exam topics.

“We certainly expect to see tightening up and much greater focus from firms,” Finra Chief Executive Officer Richard Ketchum said in an interview. “There is a high likelihood you’ll see enforcement actions as well.”

The lack of oversight is particularly thorny when brokers funnel trades to exchanges that pay them rebates for the business, Finra said. That practice can create a conflict of interest for the broker.

The Securities and Exchange Commission, which oversees Finra, and lawmakers have already been looking into rebates and other incentives that influence where brokers send client orders. Senator Carl Levin in a June hearing grilled TD Ameritrade Holding Corp. executives over the firm’s practice of selling retail orders to be filled by market makers.

Bond Trading

Finra also said that it will launch a pilot program to examine how brokers use electronic bond-trading platforms. Unlike stock exchanges, bond-trading venues generally don’t make prices available to the public. And bond dealers can block rivals and clients from seeing some prices for municipal, corporate and other bonds.

The SEC and Finra began a campaign last year to force more transparency of bond prices and markups on sales to retail customers.

Increasing price transparency could generate opposition from banks, which derive a significant portion of their income from bond trading and sales. It’s historically been more profitable to trade bonds than stocks because the debt markets are less transparent, making it easier for brokers to take a bigger fee for each exchange.

“It deserves a lot more attention,” Ketchum said.

Alternative Funds

Finra will also examine brokers’ sales of alternative mutual funds, structured retail products and bank-loan mutual funds, Finra said. The regulator will be looking for cases in which brokers may have pushed investors into large, concentrated positions in products that are highly sensitive to interest-rate changes.

Alternative mutual funds are among the fastest-growing segments of the $15 trillion fund industry. Finra said it has found some brokers aren’t adequately reviewing new alternative mutual funds, which mimic riskier hedge-fund strategies, before selling them.

“It’s important for customers to understand they are dealing with higher fees and a level of complexity,” Ketchum said. “They have to really understand the risk-return involved in the products.”

 

 

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