On October 17, Financial Industry Regulatory Authority filed with the Securities and Exchange Commission a proposed rule change to adopt NASD Rule 2320 (Best Execution and Interpositioning) and Interpretive Material (IM) 2320 (Interpretive Guidance with Respect to Best Execution Requirements) as FINRA Rule 5310 in the consolidated FINRA rulebook. Like NASD Rule 2320 (commonly known as the “Best Execution Rule”), FINRA Rule 5310 would require a member, in any transaction for or with a customer or a customer of another broker-dealer, to “use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions.” FINRA Rule 5310 is based largely on NASD Rule 2320. In addition, IM-2320 will be adopted as Supplementary Material to Rule 5310; however, it is important to note that the Supplementary Material contains the following significant changes:
- Replacement of the Three Quote Rule. NASD Rule 2320(f) (commonly referred to as the “Three Quote Rule”) generally requires members that execute transactions in non-exchange-listed securities on behalf of customers to contact a minimum of three dealers (or all dealers if three or fewer) and obtain quotations from those dealers if there are fewer than two quotations displayed on an inter-dealer quotation system that permits quotation updates on a real-time basis. The Supplementary Material eliminates the Three Quote Rule and emphasizes a member’s best execution obligations when handling customer orders involving securities (equity or debt) for which there is limited pricing information or quotations available. The Supplementary Material requires members to have written policies and procedures in place to (1) address the steps the member will take to determine the best market for securities in the absence of multiple quotations or pricing information and (2) document how they have complied with those policies and procedures. The Supplementary Material specifically notes that—when handling orders for such securities—members should 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).
- Regular and Rigorous Review of Execution Quality. The Supplementary Material codifies a member’s obligations when it undertakes a regular and rigorous review of execution quality likely to be obtained from different market centers. The Supplementary Material simply codifies guidelines set forth and explained in various SEC releases and NASD Notices to Members. See, e.g., Securities Exchange Act Release No. 37619A (September 6, 1996), 61 FR 48290 (September 12, 1996); and NASD Notice to Members 01-22 (April 2001). The Supplementary Material does not alter a member’s obligation to conduct a regular and rigorous review of execution quality. Orders for Foreign Securities with No U.S. Market. NASD Rule 2320 does not specifically distinguish between orders for domestic securities and orders for foreign securities, even in cases where there is no U.S. market for the security. The Supplementary Material notes that the obligation to use “reasonable diligence” applies to customer orders in both domestic and foreign securities. However, the Supplementary Material recognizes that 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. Accordingly, the determination as to whether a member has satisfied its best execution obligation for transactions in these securities will be based on factors such as “the character of the particular foreign market” and “the accessibility of quotations in certain foreign markets." The Supplementary Material requires members who handle customer orders for foreign securities that do not trade in the U.S. to 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. The Supplementary Material further notes that a member’s best execution obligations also must evolve as changes occur in the market that may give rise to improved executions. As a result, members must regularly review their policies and procedures to assess the quality of executions received and update or revise these policies and procedures as necessary.
- Customer Instructions Regarding the Routing of Orders. The Supplementary Material addresses situations where the customer has—on an unsolicited basis—specifically instructed the member to route its order to a particular market. Under those circumstances, the member would not be required to make a best execution determination beyond that specific instruction; however, the Supplementary Material mandates that members process the customer’s order promptly and in accordance with the terms of the order. The Supplementary Material also makes clear that where a customer has directed the member to route an order to another broker-dealer that is also a FINRA member, the receiving broker-dealer would be required to meet the requirements of Rule 5310 with respect to its handling of the order.
FINRA will announce the implementation date of the proposed rule change in a Regulatory Notice to be published no later than 90 days following SEC approval. The implementation date will be no later than 90 days following such publication.
Click here to read the Notice of Filing of Proposed Rule Change.