Mar. 06, 2023
March 6, 2023 Why is best execution important? Best execution is important because many individual investors are in the dark about the complexities of trade execution. They may not know brokers can choose how to execute a trade or that brokers may be receiving payments for using certain trading venues. Worse, individual investors may not realize there are financial implications to choosing one trading firm over another. For example: One trading venue might offer a better price Slower execution can lead to missed opportunities Information leaks can inhibit your ability to complete the customers transaction successfully Less reliable settlement processes can delay receipt of proceeds after a sale Unfortunately, individual investors cannot monitor execution quality on their own. Without the best execution rule, customers wouldnt know if a subpar trading venue is paying their broker for customer orders. They also wouldnt know that they may be paying higher transaction prices because theres a revenue arrangement between the broker and the subpar trading firm. Robinhoods best execution failure In December of 2020, the SEC charged trading app Robinhood with failure to satisfy its best execution obligation. Robinhood offers free stock trades to its customers, but earns revenue payments from the firms it uses to execute trades. The SEC complaint revealed that those firms were not providing competitive transaction prices to Robinhoods customers. Specifically, between 2015 and 2018, Robinhoods inferior execution process cost its customers $34.1 million in aggregate. And that is after considering the savings customers realized from not paying commissions on their trades. Additionally, the SEC says Robinhood repeatedly made misleading statements or omitted information from customer communications regarding its execution processes. For example, the company did not disclose that it received payments for routing trades to specific firms. Robinhood also claimed that its execution practices were as good as or better than the competitions. Robinhood did not admit to the SECs findings, but the company did pay a $65 million civil penalty. The brokerage also agreed to hire an independent consultant to review and enforce its best execution practices. Citadels best execution case In 2017, Citadel paid the SEC $22.6 million to settle best execution charges. The SEC says Citadel knowingly executed customer trades at less favorable pricing when a better price was available. Behind the scenes, Citadel used two algorithms to execute trades. One would identify when a stock order had better pricing on a faster private data feed. The other would execute the customer order at a less favorable price on a slower data feed. The company did not disclose the use of these algorithms to its customers. 12b-1 fees and best execution The SEC has also filed best execution charges against brokers for recommending mutual funds with 12b-1 fees and revenue sharing arrangements with the clearing broker. A 2020 case against SCF Investment Advisors is an example. The SEC argued that the funds SCF recommended had less favorable terms for the customer vs. funds without 12b-1 fees. SCF did not disclose the fees to the SEC as required by the Share Class Selection Disclosure Initiative.