On December 9, 2011, the SEC approved FINRA Rule 5310, which is effective May 31, 2012. Many provisions of the new rule were from the transition NASD Rule 2320. Additional provisions include members must use reasonable diligence to find the best price to execute customer trades. FINRA stated that the factors to be considered in reasonable diligence include: (i) the character of the market for the security (e.g., price, volatility, relative liquidity, and pressure on available communications); (ii) the size and type of transaction; (iii) the number of markets checked; (iv) accessibility of the quotation; and (v) the terms and conditions of the order which result in the transaction, as communicated to the member and persons associated with the member.
Further, dealer trades should not hinder the customer from getting best price. Brokers must document why they use their broker instead of the market to execute customer trades. Failure to maintain or adequately staff an over-the-counter order room or other department assigned to execute customers’ orders cannot be considered justification for executing away from the best available market; nor can channeling orders through a third party as reciprocation for service or business mitigate a member of its obligations under this Rule. Also, any member who execute orders with knowledge of, or is a party to the above prohibited arrangements, will also be deemed as violating this Rule.
Other additional provisions from prior NASD Rule 2320 were approved as follows:
Orders Involving Securities with Limited Quotations or Pricing Information. Although the best execution requirements in new Rule 5310 apply to orders in all securities, markets for securities differ dramatically. One of the areas in which a member must be especially diligent in ensuring that it has met its best execution obligations is those customer orders involving securities with limited pricing information or quotations available. Members must have written policies and procedures in place that address how the member will determine the best inter-dealer market for such a security in the absence of pricing information or multiple quotations and must document its compliance with those policies and procedures. For example, analyze pricing information based on other data, such as previous trades in the security, to determine whether the resultant price to the customer is as favorable as possible under prevailing market conditions. And, generally seek out other sources of pricing information or potential liquidity, which may include obtaining quotations from other sources (e.g., other firms that the member previously has traded within the security).
Orders Involving Foreign Securities. The obligation in Rule 5310(a) that a member use “reasonable diligence” in exercising best execution applies to customer orders in both domestic and foreign securities. However, FINRA recognizes that the markets for different securities can vary dramatically, and the standard of “reasonable diligence” must be assessed by examining specific factors, including “the character of the market for the security” and the “accessibility of the quotation.” Accordingly, the determination as to whether a member has satisfied its best execution obligations necessarily involves a “facts and circumstances” analysis. The handling of customer orders in foreign securities that do not trade in the U.S. can differ substantially from the handling of orders in U.S.-traded securities. In particular, the character of the particular foreign market and the accessibility of quotations in certain foreign markets may vary significantly. Some foreign jurisdictions, for example, may not have similar best execution requirements as those imposed by Rule 5310, or may not have comparable access and pre-trade or post-trade transparency standards. Even though a security does not trade in the U.S., members still have an obligation to seek best execution for customer orders involving any foreign security. Consequently, a member that handles customer orders involving foreign securities that do not trade in the U.S. must have specific written policies and procedures in place regarding its handling of customer orders for these securities that are reasonably designed to obtain the most favorable terms available for the customer, taking into account differences that may exist between U.S. markets and foreign markets. While best execution obligations take into account differing market structures, best execution obligations also must evolve as changes occur in the market that may give rise to improved executions, including opportunities to trade at more advantageous prices. Therefore, members also must regularly review these policies and procedures to assess the quality of executions received and update or revise the policies and procedures as necessary.
Customer Instructions Regarding Order Handling. If a member receives an unsolicited instruction from a customer to route that customer’s order to a particular market for execution, the member is not required to make a best execution determination beyond the customer’s specific instruction. However you are required to process that customer’s order promptly and in accordance with the terms of the order. Where a customer has directed that an order be routed to another specific broker-dealer that is also a FINRA member, the receiving broker-dealer to which the order was directed would be required to meet the requirements of Rule 5310 with respect to its handling of the order.
Regular and Rigorous Review of Execution Quality. No member can transfer to another person its obligation to provide best execution to its customers’ orders. A member that routes customer orders to other broker-dealers for execution on an automated, non-discretionary basis, as well as a member that internalizes customer order flow, must have procedures in place to ensure the member periodically conducts regular and rigorous reviews of the quality of the executions of its customers’ orders if it does not conduct an order-by-order review. The review must be conducted on a security-by-security, type-of-order basis (e.g., limit order, market order, and market on open order). At a minimum, a member must conduct such reviews on a quarterly basis; however, members should consider, based on the firm’s business, whether more frequent reviews are needed. In conducting its regular and rigorous review, a member must determine whether any material differences in execution quality exist among the markets trading the security and, if so, modify the member’s routing arrangements or justify why it is not modifying its routing arrangements. To assure that order flow is directed to markets providing the most beneficial terms for their customers’ orders, the member must compare, among other things, the quality of the executions the member is obtaining via current order routing and execution arrangements (including the internalization of order flow) to the quality of the executions that the member could obtain from competing markets. In reviewing and comparing the execution quality of its current order routing and execution arrangements to the execution quality of other markets, a member should consider the following factors: (i) price improvement opportunities (i.e., the difference between the execution price and the best quotes prevailing at the time the order is received by the market); (ii) differences in price disimprovement (i.e., situations in which a customer receives a worse price at execution than the best quotes prevailing at the time the order is received by the market); the likelihood of execution of limit orders; (iii) the speed of execution; (iv) the size of execution; (v) transaction costs; (vi) customer needs and expectations; and (vii) the existence of internalization or payment for order flow arrangements. A member that routes its order flow to another member that has agreed to handle that order flow as agent for the customer (e.g., a clearing firm or other executing broker-dealer) can rely on that member’s regular and rigorous review as long as the statistical results and rationale of the review are fully disclosed to the member and the member periodically reviews how the review is conducted, as well as the results of the review.