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Among the four equity market rule change proposals put forth by the U.S. Securities and Exchange Commission in December, the one with the longest backstory is Regulation Best Execution.
‘Reg Best Ex’ would establish a best execution regulatory framework for broker-dealers. The SEC noted that a best execution rule was first established in 1968 by the National Association of Securities Dealers (NASD), the predecessor to Financial Industry Regulatory Authority (FINRA), but the proposed rule would be the first SEC-established rule about best execution.
SEC Chair Gary Gensler is considered a very hands-on regulatory head, presiding over a period with the most regulatory activity since the global financial crisis of 2008-2009. But finalizing Regulation Best Execution could be the ultimate testimonial to Gensler’s enterprise, as there have been 18 SEC Chairs since 1968, all of whom could have set a best ex framework, but didn’t.
And the topic has come up many times. In 1982, David A. Lipton, then a law professor at Catholic University, published a whitepaper entitled Best Execution: The National Market System’s Missing Ingredient. In the paper, Lipton (not the IMF David Lipton) wrote: “In 1975 Congress enacted legislation designed to foster the establishment of a national system for the trading of securities. Many of the goals of a national market cannot be achieved if brokers are not compelled to seek the best price when executing transactions in multiply traded securities. To date, the Securities and Exchange Commission has failed to adopt a rule either requiring or encouraging a best execution practice.”
In the 1982 paper – published when John Shad was SEC Chairman and Ronald Reagan was U.S. President – Lipton noted the SEC had flirted with a best execution framework for at least a decade prior. In 1972, the Commission released a policy statement that emphasized the importance of “where and how to get the best price for a buyer or seller of securities.” Similar policy statements were put forth in 1973 and 1974, followed by national market system legislation in 1975 – which also did not mandate a best execution rule.
Lipton concluded: “An essential ingredient of the national market system – a broker’s obligation to execute multiply-traded securities in the best market – is missing. This missing ingredient not only impairs customers’ ability to obtain the best price, but it also impairs the operation of the basic market system components. For the national market system to function effectively, either the Commission or the courts must establish a best execution rule.”
Forty-one years later, Gensler is attempting to do just that.
How might Regulation Best Execution affect broker-dealers today? Law firm Morgan Lewis noted in December that the rule proposal appears to borrow heavily from existing Finra best ex rules, so firms wouldn’t need to start from scratch.
But details would depend on how the other three equity market rule-change proposals move forward. “At least when it comes to execution obligations in the equity markets, broker-dealers that would be subject to Proposed Regulation Best Ex would have to rely heavily on the data and reports that are produced as a result of the Equity Market Proposals if those proposals are adopted as proposed,” Morgan Lewis stated.
The law firm continued: “And although the SEC has not proposed to eliminate a broker-dealer’s receipt of PFOF [Payment for Order Flow], the additional requirements that Proposed Regulation Best Ex would place on broker-dealers that receive PFOF, coupled with the requirement in the proposed amendments to Rule 610 of Regulation NMS that rebate or other remuneration information be calculable before an order is executed, may ultimately have a chilling effect on the receipt of PFOF.”
So while an SEC regulation for best execution has proven elusive to date, perhaps regulators’ desire to rein in a modern market dynamic – payment for order flow – will be what gets it over the line.
