By John Drachman
With clients able to make trades from commission-free accounts – even in fractional shares – the lustrous sounding obligation for firms to deliver “Best Execution” trading to their clients can seem like a big yawn.
It was not always this way. Best Execution is “a significant investor protection requirement that essentially obligates a broker-dealer to… obtain the most advantageous terms for the customer,” according to the Financial Industry Regulatory Authority, Inc. (FINRA), Yet, even FINRA acknowledges that whatever is ‘best’ about Best Execution is difficult to quantify. The reason: As the circumstances of each order vary, so does the determination of which trade is “best.”
Hard to Measure
Best Execution may seem particularly irrelevant when it comes to commission-free and fractional shares; where, instead of a payment from the client, the broker counts on receiving “payment for order flow” to keep the lights on.
Regulators remind investors though that commission-free investing is not an automatic guarantee the broker is purchasing your securities at the best price. The obligation to deliver best execution trades remains in effect regardless of who places the trade. As detailed in FINRA Rule 5310, firms can receive their payments for order flow as long as they demonstrate policies are in place to ensure securities are priced with the client’s best interest in mind by:
- Comparing the quality of the executions currently obtained against the quality of executions they could have obtained within competing markets.
- Conducting reviews of certain types of orders.
- Considering speed of execution and price improvement.
When Execution is Less Than “Best”
Robinhood in 2019 provided a cautionary tale for what happens when Best Interest goes bad. FINRA found that for more than a year, the firm’s underdeveloped Best Execution policies had basically turned on the ordering spigot and left it on for the same four broker-dealers, all of which paid Robinhood for the privilege. The firm’s policy had essentially recited FINRA’s own rule back at the watchdog – a slap in the face that eventually levied a $1.25 million fine against the popular online broker-dealer.
Being in the dark concerning the nuances of trade execution is one thing. What may worse is that investors may not even realize there are financial implications to choosing one trading firm over another leading to less-than-optimal prices, slower execution and lost opportunities.
The Bottom Line
Fortunately, while you may prefer opting out of monitoring execution quality on your own, you are certainly within your rights to ask your financial advisor to explain their firm’s Best Execution policies. As they grow familiar with Best Execution’s big sister, SEC’s Reg BI rules, client-centric advisors everywhere are viewing customer interest in best practices as another opening for demonstrating the added value they are trying to bring to each relationship.
John Drachman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. John is an IABC award-winning writer, who applies his 30 years of financial marketing experience toward advancing the dialog between investors and investment professionals.
