Policies and good-faith efforts would be mandated
Broker-dealers would be required to make a good-faith effort to seek out the best available market for their customers’ orders under best execution rules proposed by the SEC in December 2022.
The proposed rule would generally require broker-dealers to have detailed policies and procedures addressing how they achieve best execution for their customers’ orders. The proposal would require broker-dealers to:
- Establish, maintain and enforce written policies and procedures designed to comply with the proposed best execution standard.
- Address in these policies how they will comply with the standard.
- Document their compliance with the best execution standard, including all efforts to enforce their best execution policies and procedures for conflicted transactions.
- Review at least annually their best execution policies and procedures, including their order handling practices. Broker-dealers would be required to document such reviews and present written reports detailing the results of such reviews to their boards of directors or equivalent governing bodies.
- Revise at least quarterly the execution quality of their customer transactions; compare it with the execution quality that might have been obtained from other markets; revise accordingly their best execution policies and procedures, including order handling practices; and document the results of the review.
Broker-dealers that engage in transactions that may pose a conflict with respect to retail customer orders would be required to implement additional policies and procedures and document their compliance with the best execution standard.
The proposal would exempt a broker-dealer from this standard when: (1) another broker-dealer is executing a customer order against the broker-dealer’s quotation; (2) an institutional customer, exercising independent judgment, executes its order against the broker-dealer’s quotation; or (3) the broker-dealer receives an unsolicited instruction from a customer to route its order to a particular market for execution and the broker-dealer processes that customer’s order promptly and in accordance with the terms of the order.
For the purposes of this rule, the SEC would create a category known as an “introducing broker” that (1) does not carry customer accounts or hold customer funds or securities; (2) has an arrangement with an unaffiliated broker-dealer (an “executing broker”) that has agreed to handle and execute on an agency basis all the introducing broker’s customer orders; and (3) has not accepted remuneration, compensation or consideration from the executing broker in return for servicing customer orders.
Broker-dealers that qualify as introducing brokers under the proposed regulation would be exempt from many of the operative provisions of the rule if they:
- Establish, maintain and enforce policies and procedures that require them to regularly review the execution quality obtained from their executing brokers.
- Compare that execution quality with the execution quality they might have obtained from other executing brokers.
- Revise their order handling practices accordingly.
Introducing brokers would be required to document the results of this review.
Comparing SEC proposal to FINRA rule
The SEC proposal would join a FINRA rule in requiring brokers to disclose information about the routing and execution of their customers' orders. However, the specific disclosure requirements would differ between the two. We highlight some of these below:
Overall, while there are some differences between the SEC proposal and FINRA's rules, both are designed to promote fair and efficient trading and to protect investors by ensuring that their orders are executed in a manner consistent with their best interests.
How to comply
To facilitate compliance with the FINRA rule and the SEC’s proposal, broker-dealers may wish to:
- Conduct current state assessment:
- Review current policies and procedures to conduct gap analysis against rules and regulations
- Perform current-state and future-state assessment per regulatory guidelines and leading industry practices
- Identify areas of opportunities that exist in the current state
- Implement and assess policies, procedures and controls:
- Assist in developing and implementing new or enhanced policies and procedures
- Assess current controls to align with regulatory guidance and industry/best leading practices
- Perform monitoring and testing:
- Conduct regular testing and monitoring of best execution practices to verify ongoing compliance
- Develop, measure and monitor corrective action plans or remediation plans
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