Identifying and Avoiding Prohibited Practices with Customer Orders

What a firm may not do while holding a customer order, and when it may trade anyway.

Which One-Liners Win Points?

• Four facts trigger the rule: an equity order, held without immediate execution, a same-side proprietary trade, and a price that would satisfy it. Another broker-dealer's customer is protected too.
• The cure is timed, sized and priced: immediately thereafter, up to the size the member traded, at the same or better price than its own trade.
• Every effort: execute a marketable customer order fully and promptly, and cross a held marketable order with an opposite-side order, up to its size, at or between the best bid and offer when the later order arrives, consistent with the orders' terms.
• The manipulative and deceptive devices rule reaches effecting or inducing a trade in any security by a manipulative, deceptive or other fraudulent device, with no exception or threshold.
• A broker-dealer escapes the adviser definition only if its advice is solely incidental and it receives no special compensation.

Which Numbers Matter Most?

Which Exceptions Let a Member Trade Ahead?

• Large orders and institutional accounts: clear and comprehensive written disclosure at account opening and annually offering a meaningful opportunity to opt in, not out, or clear and comprehensive oral disclosure and consent order by order, where the member documents who consented and the consent evidences the customer's understanding of the order's terms and conditions.
• No knowledge: effective internal controls, such as information barriers. In an OTC equity security, only a non-market-making unit may trade.
• Riskless principal: a contemporaneous report identifying the trade as riskless principal, and written procedures requiring at a minimum the customer order first, the same price exclusive of any mark-up or fee, and allocation within 60 seconds.
• Intermarket sweep orders: trading from a sweep routed before the customer order arrived, or for a customer who consented to forgo the better prices.
• Odd lots and bona fide errors: only the error branch must be demonstrated and documented.

Which Gotchas Trip Students Up?

• Price the order first: 10,000 shares at $5.00 is $50,000, outside the size branch, though an institutional account still qualifies.
• Once a held limit order is triggered, every better-priced customer limit order is protected too.
• The odd-lot branch uses the stock's assigned round lot, not a flat 100 shares.
• Agreeing to process an order outside normal market hours extends the protections to all times it is executable.

One-Breath Recap

A member holding a customer equity order may not trade that security on the same side for its own account at a price that would satisfy it, unless it immediately fills the customer up to the size it traded, at the same or better price, or an exception applies: large orders or institutional accounts with opt-in disclosure, no knowledge behind effective controls, riskless principal, intermarket sweep orders, and odd-lot or bona fide error trades. Trading past a held national market system stock limit order at $1 or more and not outside the best inside market needs a penny of price improvement. The manipulative and deceptive devices rule has no exceptions; an adviser knowingly trading as principal with a client, except a broker-dealer not acting as adviser in that transaction, needs written capacity disclosure and consent before completion.

Need more than the recap? Read the full Identifying and Avoiding Prohibited Practices with Customer Orders unit.