Statement on Best Execution Proposal
Dec. 14, 2022
Today, the Commission will consider a proposal to establish a Commission rule setting forth a best execution standard and accompanying framework for broker-dealers. I am pleased to support this proposal because, if adopted, it would help ensure that brokers have policies and procedures in place to uphold one of their most important obligations: to seek best execution when trading securities, whether equities, fixed income, options, crypto security tokens, or other securities.
When I started at the Securities and Exchange Commission, shortly after the meme stock events, I asked a colleague to provide a copy of our best execution rule. Having been around finance for about four decades, I was aware of the duty of best execution and wondered if there were any gaps in the rule, in light of recent market developments.
Well, I was surprised to learn, the SEC didn’t actually have its own best execution rule! The best execution rule for broker-dealers was instituted by the Financial Industry Regulatory Authority (FINRA), a self-regulatory organization (SRO). The predecessor to FINRA first adopted a version of a best execution standard in 1968. In 2016, the Municipal Securities Rulemaking Board (MSRB) implemented a separate rule for broker-dealers dealing in municipal securities. The Commission has been enforcing the duty of best execution under the antifraud statutes for decades, and FINRA enforces its standards (and the MSRB standard).
FINRA plays a critical role as a membership organization for broker-dealers. It was first registered in 1939 after passage of the Maloney Act of 1938 as the National Association of Securities Dealers (NASD), a key component of President Franklin Delano Roosevelt’s broad legislative agenda for our markets. We’ve benefited greatly from NASD’s role, then FINRA’s, ever since. We have many rules about broker-dealers at the SEC, and FINRA also has rules and guidance. That’s true in a variety of areas, whether it’s the standards to protect customer funds or brokers’ obligations when making a recommendation, to name just a couple.
I believe a best execution standard is too important, too central to the SEC’s mandate to protect investors, not to have on the books as Commission rule text.
Further, FINRA’s best execution rule was last updated in 2014. A lot has changed in our markets since then, not to mention since 1968. Today, equities often trade on off-exchange dark venues that have different business models and are less transparent than the familiar lit exchanges.
Such developments in our markets make best execution that much more important. They also raise a number of questions about how brokers handle their best execution obligations in light of conflicts of interest that may lead broker-dealers to place their own interests ahead of their customers’ interests.
What would a Commission-level best execution standard mean in practice? It would enhance investor protection by providing for additional enforcement capabilities, including the ability to bring remedial actions and impose sanctions for violations of the new rule. This, in turn, would reinforce and bolster the SROs’ own enforcement efforts.
In addition, the proposal would make a number of enhancements regarding brokers’ core duty to everyday investors. I will highlight three:
First, the proposal would heighten the requirements for transactions that involve conflicts of interest with retail investors. For the first time, if a broker has conflicts of interest with respect to a transaction, the broker would be subject to additional policies and procedures and documentation requirements. For example, if brokers receive payment for order flow from a wholesaler, those brokers would be required to have policies and procedures that reflect enhanced diligence in seeking best execution and would be required to document their basis for determining that conflicted transactions comply with the best execution standard.
Second, the proposal would narrow the scope of introducing brokers that would be exempt from certain best execution requirements. For example, say an investor has an account with a broker-dealer that sends its trades to a wholesaler from whom they get payment for order flow. The proposal clarifies that this broker cannot solely rely on the executing broker’s execution quality review. I think it makes sense that this broker the investor hired remains on the hook, rather than “outsourcing” this obligation to the executing broker.
Third, the proposal specifies in greater detail the policies and procedures that brokers need to adopt with respect to best execution, while retaining their ability to consider a variety of factors in determining the best market for customer orders. These policies and procedures would be required to include specific considerations that a broker would need to address in order to comply with the proposed best execution standard, such as the information used to evaluate markets. These policies and procedures also would have to address specified price and non-price considerations relevant to determining the best markets for customer orders.
Altogether, I believe a best execution standard at the Commission level, as well as the proposed enhancements I just discussed, would lead to better execution for retail and institutional investors. Subject to Commission approval, I look forward to feedback from the public, in particular from individual investors.
I’d like to thank members of the SEC staff who worked on this rule, including:
- Haoxiang Zhu, Andrea Orr, David Saltiel, David Dimitrious, David Shillman, Eric Juzenas, Roni Bergoffen, Marilyn Parker, Deborah Flynn, Arisa Tinaves Kettig, Jennifer Colihan, Yue Ding, Adam Large, William Miller, Alex Jadin, and Richard Schwinn in the Division of Trading and Markets;
- Seung Won Woo, Laura Tuttle, Michael Walz, Jessica Wachter, Oliver Richard, Lauren Moore, Amy Edwards, Charles Woodworth, Jill Henderson, Su Li, John Ritter, Thomas Shohfi, Andrew Glickman, Patti Vegella, Louis Craig, Paul Hughes, Qiyu Liu, Daniel Bresler, and Matt Pacino in the Division of Economic and Risk Analysis;
- Dan Berkowitz, Megan Barbero, Meridith Mitchell, Malou Huth, Robert Teply, Janice Mitnick, Cynthia Ginsberg, Ronesha Butler, David Mendel, Amy Scully, Tracey Hardin, Brooke Wagner, Daniel Staroselsky, Laura Jarsulic, Ian Dattner, and Stephen Ng in the Office of the General Counsel;
- Mandy Sturmfelz, Joseph Sansone, Carolyn Welshhans, Steven Buchholz, Jonathan Max Warner, Andrew McFall, and Ainsley Kerr in the Division of Enforcement;
- John Polise, Katherine Monahan, Constance Kiggins, Carrie O'Brien, and Bradley Abel in the Division of Examinations;
- Dave Sanchez, Adam Wendell, and Adam Allogramento in the Office of Municipal Securities; and
- Sarah ten Siethoff, Thoreau Bartmann, Marc Mehrespand, and Matt Cook in the Division of Investment Management.