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April 3, 2023

SEC Market Structure Reforms: Regulation Best Execution

Better Markets filed a comment letter with the Securities and Exchange Commission in response to the proposed Best Execution Rule, one of four reforms to the structure of U.S. financial markets. This proposed rule would establish a duty of best execution at the SEC, requiring broker-dealers to execute customer orders at the most favorable price given market conditions.

Why It Matters. The U.S. financial markets have become enormously fragmented and largely opaque, including 24 exchanges, dozens of ATSs, and a cadre of wholesalers—market participants that for their own benefit, attract and execute a huge percentage of retail order volume. As a result, finding the best prices poses challenges. There are huge conflicts of interest in play when it comes to order execution, and that profit motive induces some market participants to route orders for execution in ways that do not yield best execution for clients. Specifically, sophisticated market participants such as the wholesalers can game the system through the process of PFOF—paying brokers for retail order flow, executing those orders internally at prices that reflect apparent price improvement over the NBBO benchmark, and then, in turn, engaging in offsetting trades at better prices for their own gain.

What We Said.  The proposed rule represents an important step forward in the effort to ensure that retail investors obtain something closer to the best available prices for their securities trade, instead of being taken advantage of by broker-dealers who sell their customers’ order flow to large, sophisticated wholesalers that execute orders at less than the best available price. Having a Commission rule in place—not only an SRO rule—will by itself confer a number of important advantages, enabling the Commission to use the rule in its examination efforts and enforcement actions. However, it is not sufficient by itself to address the problems surrounding retail order execution and it therefore cannot be viewed in isolation. It is part of a set of market structure rule proposals that will require greater retail order competition, reduced tick sizes, and enhanced disclosure about execution quality.  It is important that all of these reforms take effect to maximize the improvements to retail order routing and execution practices that the Commission is appropriately seeking to achieve. Moreover, the Commission should consider additional reforms, including banning the incentives—notably PFOF—that are largely responsible for the conflicts of interest that degrade order routing and execution practices to the detriment of retail investors.

Bottom Line. The SEC’s proposed rule to establish Regulation Best Execution would increase regulatory oversight and enforcement of a broker-dealer’s duty to execute their customer orders at the best price given market conditions. While the proposed rule stops short of banning the harmful practice of PFOF (which we advocate for eliminating in the comment letter), the heightened policies and procedures for conflicted transactions such as PFOF should root out the most egregious instances of broker-dealers acting against the best interests of their customers in executing their trades.

Read our full Comment Letter here or click the button below.

Comment Letters

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