Best Execution Obligations

Every time a firm handles a customer order, it has a duty to seek the best possible outcome. FINRA's best-execution and interpositioning rule defines this obligation and is a frequent exam topic.

What Does Best Execution Require?

• In any transaction for or with a customer, a firm must use reasonable diligence to ascertain the best market for the security and execute the order so the resultant price is as favorable as possible under prevailing market conditions
• This obligation applies whether the firm acts as agent or principal
• Best execution applies to orders from both the firm's own customers and customers routed from other broker-dealers
• This duty is non-delegable: a firm cannot transfer its best execution obligation to another party

Exam Tip: Gotchas

• Best execution applies to BOTH agent and principal transactions. The obligation exists regardless of capacity.

What Factors Determine Best Execution?

Best execution is not simply about finding the best price. FINRA considers multiple factors:

• Character of the market for the security (price, volatility, relative liquidity)
• Size and type of the transaction
• Number of markets checked
• Accessibility of quotations
• Terms and conditions of the order

Think of it this way: Best execution is like choosing a flight. The cheapest ticket is not always the best option; you also consider departure time, number of stops, airline reliability, and baggage fees. Similarly, a firm must weigh price, speed, likelihood of execution, and total transaction cost.

Exam Tip: Gotchas

• Best execution is NOT just about getting the best price. It requires "reasonable diligence" considering multiple factors including speed of execution, likelihood of execution, and overall transaction cost. A firm that always routes orders to a venue paying the highest rebate without considering execution quality is violating its best-execution obligation.

How Often Must Firms Review Execution Quality?

Firms must systematically evaluate execution quality:

• If a firm does not conduct order-by-order best execution review, it must conduct "regular and rigorous" reviews
• Regular and rigorous reviews must occur at a minimum quarterly
• Reviews must be on a security-by-security, type-of-order basis (e.g., market orders reviewed separately from limit orders)
• Firms with payment for order flow (PFOF) arrangements must apply heightened scrutiny to ensure routing decisions do not compromise execution quality

Exam Tip: Gotchas

• Payment for order flow is not prohibited, but it requires heightened scrutiny. A firm accepting PFOF must still prove its routing decisions deliver best execution.
• Regular and rigorous reviews must happen at least quarterly. If a firm skips order-by-order review, the quarterly review requirement kicks in as the minimum standard.

When Is Interpositioning a Violation?

• A firm may not insert a third party between itself and the best available market unless doing so results in a better price for the customer
• Interpositioning that increases the customer's cost without providing a corresponding benefit is a violation
• Example: Routing a customer order through an affiliate just to generate an additional markup, resulting in a worse price for the customer, is a violation

Exam Tip: Gotchas

• Interpositioning is only acceptable if it results in a better price for the customer. Inserting a third party just to collect an extra fee is always a violation.

What Should You Check on Exam Day?

• Do not equate best execution with the single lowest price; check whether the scenario weighs speed, likelihood of execution, and cost together.
• Confirm the best-execution duty applies whether the firm acts as agent or principal, and cannot be delegated away.
• Flag any payment-for-order-flow scenario as requiring heightened scrutiny, not prohibition.
• Treat interpositioning as a violation unless it demonstrably produces a better price for the customer.