What Is Best Execution?
Best execution is a legal mandate that requires brokers to seek the most favorable options to execute their clients' orders within the prevailing market environment.
Best execution is a significant investor protection requirement that obligates a broker to exercise reasonable care when executing an order to obtain the most advantageous terms for the customer.
It requires brokers to examine, track, and document when routing an equity investment, an option, or a bond order for execution.
- Best execution requires brokers to provide customers with the most advantageous order execution.
- Best execution is a law that puts clients’ interests first and above broker incentives.
- Brokers consider the best price, speed of execution, and the likelihood of trade execution when evaluating a client request.
How Best Execution Works
Best execution is both an ethical guideline and a legal mandate. It ensures brokers place their clients' interests first when routing trades for execution. Broker incentives, such as commissions, are secondary to the customer's needs.
The Security and Exchange Commission (SEC) oversees execution standards and broker-dealers must report to the SEC quarterly on how client orders are routed. The Financial Industry Regulatory Authority (FINRA) also conducts routine examinations and audits of brokerage firms' best execution practices.
FINRA Rule 5310
The Financial Industry Regulatory Authority's Rule 5310, or Best Execution Rule, requires that in any transaction for or with a customer or a customer of another broker-dealer, a member and persons associated with a member shall use reasonable diligence to ascertain the best market for the subject security, and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. Firms must conduct a “regular and rigorous” review of the execution quality of customer orders or an order-by-order review.
Requirements for Best Execution
Key factors that brokers consider when executing customer orders include the opportunity for a better price than quoted, speed of execution, and the likelihood of trade execution. Best execution also includes other factors, such as the time for settlement and the size of the trade.
In Europe, best execution regulations were introduced in 2018, entitled Markets in Financial Instruments Directive (MiFID) II. These regulations helped boost the initial MiFID regulations that were introduced in 2007. The regulation ensures brokers take “sufficient steps” to ensure favorable execution for clients, versus “reasonable steps.”
How Does an Investor Know How a Broker Follows the Best Execution Rule?
Investment companies often provide full disclosure of order execution policies. BlackRock, for example, documents its best execution and order placement protocols for clients in the company's Best Execution and Order Placement disclosure.
What Is MiFID II?
MiFID II is similar to the Best Execution Rule in the U.S. and is a legislative framework instituted by the European Union (EU) to regulate financial markets in the bloc and improve protections for investors to standardize practices across the EU.
What Happens When Companies Do Not Follow Best Execution?
In December 2020, the SEC charged Robinhood Financial LLC for repeated misstatements that failed to disclose the firm’s receipt of payments from trading firms for routing customer orders to them, and with failing to satisfy its duty to seek the best reasonably available terms to execute customer orders. According to the SEC’s order, Robinhood falsely claimed in a website FAQ between October 2018 and June 2019 that its execution quality matched or beat that of its competitors.