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Regulation and Compliance > Federal Regulation > SEC

SEC Proposes New Best-Execution Rule, Draws Criticism

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What You Need to Know

  • An investor advocate called the proposal a disappointment.
  • Republican commissioners pointed out that FINRA and the MSRB already have best-execution rules.
  • The SEC also proposed a sweeping package of market structure changes that drew criticism from industry trade groups.

The Securities and Exchange Commission on Wednesday approved for public comment proposed Regulation Best Execution, which would set forth the agency’s best-execution standard for client trades.

Industry experts told ThinkAdvisor Wednesday that the SEC’s proposed Regulation Best Execution fails to improve upon the Financial Industry Regulatory Authority’s outdated best execution rule and continues to permit payment for order flow.

Under the SEC’s Regulation Best Execution, “specifically, in any transaction for or with a customer or a customer of another broker-dealer, a broker-dealer (or a natural person who is an associated person of the broker-dealer) would be required to use reasonable diligence to ascertain the best market for the security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions,” the agency said.

The SEC Reg Best Ex proposal would require broker-dealers to:

● Establish a best-execution standard for brokers, dealers, government securities brokers, government securities dealers, and municipal securities dealers (collectively “broker-dealers”);

● Require broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to comply with the best-execution standard;

● Require more robust policies and procedures for broker-dealers that engage in certain conflicted transactions for or with a retail customer;

● Require broker-dealers to review the execution quality of their customer transactions at least quarterly;

● Exempt broker-dealers that qualify as “introducing brokers” from certain requirements if they establish, maintain, and enforce specified policies and procedures; and

● Require broker-dealers to review their best execution policies and procedures at least annually and present a report detailing the results of such review to their boards of directors or equivalent governing bodies.

A ‘Huge Disappointment’

Tyler Gellasch, president and CEO of Healthy Markets Association in Washington, told ThinkAdvisor Wednesday in an email that with its proposed Regulation Best Execution, “the SEC has proposed taking control of best execution enforcement, but essentially preserving the status quo. It’s a huge disappointment for investors, who had been hoping that this SEC wouldn’t just take responsibility for best execution, but also make it work for investors.”

The SEC’s proposed best execution rule “largely mirrors rather than substantively improves upon the existing FINRA rule,” added Gellasch, a former counsel in the U.S. Senate as well as counsel to former SEC Commissioner Kara Stein. “And while that could step up enforcement, there’s a significant question about whether it would materially better protect investors.”

SEC Commissioner Hester Peirce, a Republican, noted during the SEC open meeting Wednesday that she believed confusion will ensue with three best execution rules — those of the SEC, FINRA and the Municipal Securities Rulemaking Board.

SEC Chairman Gary Gensler, however, stated at the open meeting that when he arrived at the agency he was “surprised” to learn that the SEC didn’t have a best-execution rule. “FINRA plays a really critical role as a membership organization for broker-dealers … it’s an important part of the mix, but I would say that we have many rules where the SEC has a role and FINRA has a role.”

Republican Commissioner Mark Uyeda opined that “an obvious problem 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?

Payment for Order Flow

Ron Rhoades, associate professor of finance at Western Kentucky University and director of its personal financial planning program, told ThinkAdvisor in another email that “while having a best execution rule that the SEC itself can enforce (rather than just FINRA) is a positive step, I don’t foresee that this rule will dramatically improve trade execution quality for customers of broker-dealers.”

The SEC’s proposed rule “continues to permit payment for order flow, an insidious conflict of interest and a means of doing business that was popularized by Bernie Madoff. In the end, under principles of agency, the execution of trades on behalf of a broker’s customer imposes upon the broker a fiduciary duty to act in the customer’s best interest when executing the trade,” Rhoades said.

“If the broker has the opportunity to secure additional compensation, such as through payment for order flow, this conflict of interest will lead to breaches of the fiduciary obligation,” according to Rhoades. “Simply put, a fiduciary cannot serve two masters.”

‘Complicated’ Market Changes

The SEC proposed its new Regulation Best Execution as part of a package of broad equity market structure changes.

The agency adopted amendments to Rule 10b5-1 and new disclosure requirements to enhance investor protections against insider trading; proposed amendments to update the disclosure required for order executions in national market system (NMS) stocks; proposed amendments to the minimum pricing increments, also known as tick sizes; as well as proposed a rule to require certain orders of individual investors to be exposed to competition in fair and open auctions.

Gail Bernstein, general counsel for the Investment Adviser Association in Washington, added in another email that “the SEC issued a package of extremely complicated equity market structure rule proposals under the Exchange Act that, if adopted, will change the landscape for how retail orders are quoted, priced, routed, and filled.”

Among other things, Bernstein continued, “the package calls for retail equity orders to be exposed in open auctions, changes broker-dealers’ best execution obligations, and requires significant new disclosures relating to treatment of retail orders.” IAA, Bernstein said, “will review these proposals carefully to assess their potential implications for investment advisers.”

Ken Bentsen, president and CEO of the Securities Industry and Financial Markets Association, added in a statement that “the substantial changes proposed today by the SEC are incredibly complex with material impact to all market participants, but particularly to investors. We strongly believe the SEC needs to be extremely careful in its approach.”

Added Bentsen: “Any changes being proposed in the name of competition which may tilt the playing field at the expense of investors should be weighed carefully, be subject to a robust cost benefit analysis, and considered holistically with a view to ensuring there are no negative, unintended consequences for investors.”

As the proposals issued Wednesday “are significantly complex and interrelated, it is essential the SEC provide an adequate comment period to allow all parties sufficient time to provide thoughtful input on the package of proposals,” Bentsen said.


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