best execution

MSRB Rule G-18, effective March 21, 2016, establishes a best-execution rule for municipal security transactions. The rule requires brokers and dealers to make reasonable efforts to find as favorable a price as possible for a customer’s transaction, given the prevailing conditions of the market. G-18 is comparable to FINRA Rule 5310, though it is designed specifically to meet the needs of the municipal securities market.

In deciding how and where to execute a trade, a broker-dealer is expected to consider these factors:

• The character of the market for the security, such as its price, volatility, and liquidity
• The size and the type of transaction
• The number of markets checked
• The information reviewed to determine the current market for the security or similar securities
• The accessibility of the quotation
• The terms and conditions of the transaction as communicated to the broker-dealer

Because municipal securities trade over-the-counter, the term “market” should be interpreted broadly to include trading among broker’s brokers, alternative trading systems, or other counter-parties. Dealers must be especially vigilant with transactions in markets where trading is thin and limited pricing information is available.

If a dealer does not get the best price possible in the market, this does not necessarily mean that reasonable diligence was not used. However, if the dealer makes another trade soon after and gets a better price for a similar security and there has been no significant change in the market, this is an indicator that the dealer did not use reasonable diligence.

The following are a few examples of characteristics that may be used to determine if two securities are similar:

• Issuer
• Source of repayment
• Credit rating
• Coupon
• Maturity
• Redemption features
• Sector of the market
• Geographical region
• Tax status

Broker-dealers must institute written policies and procedures that address how they will make a best-execution determination in the absence of pricing information or multiple quotations. They must document compliance with those policies and conduct reviews at least once a year to assess their effectiveness.

Broker-dealers are exempt from the best execution requirement when acting on behalf of a sophisticated municipal market professional (SMMP). An SMMP is:

• A bank, savings and loan association, insurance company, or investment company
• A registered investment adviser
• Any other individual or entity having total assets of at least $50 million

Note: Because broker-dealers are not considered to be customers, the best-execution standard does not have to be applied to trades between broker-dealers that are not on behalf of a customer.

This post is relevant to the Series 52 and Series 53.

The SEC has approved changes to FINRA’s Best Execution rule that will take effect on May 31, 2012. Four new pieces of supplementary material were added to the rule that address the following topics: securities with limited quotation or pricing information, orders for securities with no U.S. market, customer instructions regarding the routing of orders, and regular and rigorous reviews of execution quality. The new rule is otherwise generally similar to the old rule.

Here is a breakdown of the new supplementary material:

1. Supplementary Material .06: Securities with Limited Quotation or Pricing Information

This material replaces the old “Three Quote Rule.” The new material does not specify a minimum number of quotes that must be obtained – rather, it emphasizes that members must be diligent in complying with best execution practices when there are customer orders for securities with limited quotation or pricing information. The material requires that the member have written policies in place to ensure that they meet their best execution requirements.

2. Supplementary Material .07: Orders for Foreign Securities with No U.S. Market

This material states that in order to determine if a firm used reasonable diligence in executing orders in a given market, the firm must analyze the “facts and circumstances” of the situation. The material requires that if a firm trades in a security that does not trade in the U.S., the firm must have written policies in place to ensure best execution of customer orders. The policies must be reviewed regularly.

3. Supplementary Material .08: Customer Instructions Regarding the Routing of Orders

This material specifies that when a customer requests the firm to route their order to a specific market, the firm is not required to make a best execution determination beyond the customer’s instructions. The firm must still process the customer’s order promptly, however.

4. Supplementary Material .09: Regular and Rigorous Review of Execution Quality

This material codifies existing requirements for reviewing the firm’s execution quality. These requirements were previously established through SEC releases and FINRA notices.

Source: FINRA Regulatory Notice 12-13

This alert applies to the Series 62, Series 55, Series 24, and Series 99.

Tag: best execution

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