Trading Ahead of Customer Orders

The trading ahead of customer orders rule is known on the desk by an older nickname, the Manning rule. It does not ban proprietary trading while a customer order rests. It bans a same-side proprietary trade at a price that would satisfy the held order, unless the member fills that customer immediately afterwards on the terms the rule sets.

Which Facts Trigger the Trading Ahead Prohibition?

The prohibition opens with the words "Except as provided herein," so it is read together with the eight items of Supplementary Material that follow it. Inside that frame, four facts have to hold together.

The order can come from the member's own customer or from a customer of another broker-dealer. Either origin is inside the rule, and the duty-bearer the text names is the member.

Exam Tip: Gotchas

• The rule's subject is an order in an equity security, and the paragraph names no other product. A scenario that moves the held order into a different instrument moves it outside this paragraph's own terms.
• The order does not have to belong to the member's own customer. The text reaches an order from its own customer or a customer of another broker-dealer, so order flow routed in from another firm carries the same protection.
• A same-side proprietary trade at a price that would not satisfy the held order is outside the prohibition's own sentence. All four facts have to hold together, so the price test does real work in a fact pattern. For a held limit order, though, the minimum price improvement standards still require the fill unless the member's price betters the limit by at least the standards' minimum.

How Does a Member Cure a Trade That Would Otherwise Violate the Rule?

The prohibition applies unless the member immediately thereafter executes the customer order. That cure sits in the same sentence as the prohibition and carries two limbs at once.

• Size: the customer order is executed up to the size at which the member traded for its own account.
• Price: the customer order is executed at the same or better price at which the member traded for its own account.

So a firm that buys 5,000 shares for its own account at a price that would satisfy a held customer buy order, and has no exception to rely on, stays outside the prohibition only by immediately thereafter filling that customer up to 5,000 shares at that price or better.

Exam Tip: Gotchas

• The cure is timed, sized and priced, and losing any part of it loses the cure. "Immediately thereafter," "up to the size" the member traded, and "at the same or better price" at which it traded all sit in one clause.
• The cure price is anchored to the member's own execution. The rule says the same or better price at which the member traded for its own account, so that trade, not the customer's limit, sets the price the fill must match or improve on.
• A partial fill can still be a cure. The rule requires execution up to the size the member traded for its own account, which is a ceiling on the size owed, not a promise to fill the whole order.

What Written Methodology Must a Member Have and Apply Consistently?

A member must have a written methodology in place governing the execution and priority of all pending orders. That methodology must be consistent with the requirements of the trading ahead of customer orders rule and with the best execution rule.

The rule then adds a second duty in its own sentence. A member also must ensure that this methodology is consistently applied.

The best execution requirements themselves, including the reasonable diligence standard and the ban on interpositioning, are covered in the unit on meeting obligations to customers regarding orders.

Exam Tip: Gotchas

• The methodology paragraph carries two duties, not one. Having the written methodology is the first; ensuring it is consistently applied is a separate sentence with its own verb, so a good document applied unevenly still fails.
• The methodology reaches all pending orders, and both their execution and their priority. A procedure that addresses execution alone is narrower than what the paragraph names.
• The methodology has two consistency targets. It must be consistent with this rule and with the best execution rule, so a priority scheme that satisfies one and defeats the other is not compliant.

What Should You Check on Exam Day?

• Confirm the held order is an equity order, and that the member's own trade was on the same side of the market at a price that would satisfy it.
• Check whether the member executed the customer order immediately thereafter, up to the size it traded and at the same or better price.
• Do not limit the rule to the member's own customers; an order from another broker-dealer's customer is inside it.
• Ask whether an exception applies before calling it a violation, because the paragraph opens "Except as provided herein."
• Confirm the written methodology covers execution and priority of all pending orders, and that the firm applies it consistently.