Best Execution Obligations

Every broker-dealer has a fundamental duty to get the best possible price for customer orders. This section covers that obligation and its most common violations.

FINRA Rule 5310 - Best Execution and Interpositioning

Members must use reasonable diligence to determine the best market for a security and execute so that the price to the customer is as favorable as possible under prevailing market conditions.

Factors to Consider

When determining best execution, a firm must evaluate:

• The character of the market for the security (price, volatility, liquidity)
• Size and type of the transaction
• Number of markets checked
• Accessibility of the quotation
• Terms and conditions of the order

Best execution applies to all customer orders regardless of how they are received.

Interpositioning Prohibition

• A member may not interject a third party between itself and the best market in a manner that results in a worse price for the customer
• Example: Routing a customer order to a third-party dealer instead of executing directly with the best market, resulting in an additional markup that the customer ultimately pays
• Exception: Using a broker's broker is acceptable if the member can demonstrate it resulted in a better execution for the customer
• The burden of proof for justifying interpositioning is on the member firm

Think of it this way: The firm should not add unnecessary middlemen that increase the customer's cost.

Exam Tip: Gotchas

• The interpositioning burden of proof is on the firm, not the customer. If a third party was used, the firm must prove it resulted in a better price.
• Interpositioning is a violation only when it results in a worse price for the customer. If the third party actually improves execution, it is permitted.

Payment for Order Flow

• Some market makers pay broker-dealers for routing customer orders to them
• The firm receiving payment for order flow must still meet its best execution obligation - the payment cannot result in the customer receiving a worse price
• The firm must disclose its payment-for-order-flow practices on customer confirmations

Think of it this way: Accepting payment for order flow (PFOF) is allowed, but it cannot compromise the customer's execution quality. The firm must be able to show that execution quality is at least as good as what was available elsewhere.

Exam Tip: Gotchas

• PFOF does not excuse poor execution. A firm that routes orders to a market maker paying for order flow must still demonstrate the customer received a price at least as good as what was available elsewhere.
• Best execution requires "reasonable diligence," not perfection, but the standard is rigorous.
• Best execution applies to all customer orders, including those routed from other firms.