FINRA Rule 5310: What Happens When a Stockbroker Fails to Execute?
“Failure to execute” is a type of broker misconduct. Failure to execute could indicate that a broker simply failed to execute the trade as instructed. It could also describe a trade that did not happen quickly enough to achieve the desired price, or a trade that failed to meet the standards of “best execution.”
What is “Best Execution” in the Securities Industry?
The Financial Industry Regulatory Authority (FINRA) requires brokers to execute trades in a timely manner and for the best price possible.
Placing a trade is not as simple as pushing a button. It costs money to execute a securities transaction and research to determine if the investor is getting the best price possible for their trade. Different markets — i.e., stock exchanges like the NASDAQ and New York Securities Exchange (NYSE) — might charge different amounts for a securities transaction, depending on the security and the size of the trade.
FINRA Rule 5310 states that brokers must use reasonable diligence to ascertain the best market for a security, considering the following factors:
- The size and type of transaction.
- The number of markets checked.
- Accessibility of the quoted price of securities.
- The terms and conditions of the order resulting in the transaction as communicated to the broker.
Brokers must check all the relevant markets to find the “National Best Bid and Offer” (NBBO) before they can make an informed decision.
What Happens When a Brokerage Firm Cannot Place a Trade?
Broker-dealers would generally prefer to place orders using securities from their own inventory—i.e., shares of a stock they already own, so they can make money off the difference between the selling price and the purchase price. But brokerage firms may not be able to execute every trade. In this case, Rule 5310 states, “When a member cannot execute directly with a market but must employ a broker’s broker or some other means in order to ensure an execution advantageous to the customer, the burden of showing the acceptable circumstances for doing so is on the member.”
Why Do We Need FINRA Best Execution Rules?
The SEC wants to ensure “vigorous competition among buyers and sellers in an individual security, particularly through an opportunity for their orders to interact directly.” In 2001, the SEC estimated that investors could have saved $110 million if markets charged similar prices.
The Securities and Exchange Commission (SEC) introduced best execution requirements in response to market fragmentation. “Market fragmentation” refers to the existence of multiple markets. While competition benefits investors, it only works in investors’ favor if brokers do their research.
Why Do Brokers Fail to Execute Transactions?
Brokers have been known to ignore their investor’s instructions to execute a trade, perhaps because they believe that the price of the trade will improve, and their commission will therefore increase. Brokers might also believe that they have a more sophisticated understanding of an investor’s strategy, and simply think they should follow their instincts. If an investor loses money because their broker fails to follow their instructions, they should speak with a securities attorney.
Trade orders may slip through the cracks, especially when a broker has many clients. It could also be that the brokerage does not have sufficient staff in the order room. According to FINRA rules, firms cannot use insufficient staffing as an excuse for failing to execute trades in a timely manner.
Robinhood and Payment for Order Flow
Robinhood Markets has come under serious scrutiny for potentially undermining FINRA’s rules regarding best execution. Payment for order flow (PFOF) allows a market maker to pay brokerage firms for a bulk order of their trades. Market centers are willing to pay for these to have a continuous flow of transactions. The SEC has concerns that PFOF does not incentivize brokers to find the best prices for their trades, which is why the SEC has recently threatened to ban the practice.
The SEC states that “a broker-dealer must not allow a payment or an inducement for order flow to interfere with its efforts to obtain best execution.”SEC Rule 11Ac1-6 requires that broker-dealers disclose which market centers they use. Broker-dealers must also reveal any potential conflicts of interest, including any payment for order flow.
Example of a Failure to Execute
Many examples of failure to execute include limits or stop-loss orders. As the name suggests, these are orders designed to limit an investor’s losses. In one instance, a group of brokers chose an investing strategy that included shorting U.S. Treasury bonds. “Shorting” means betting that the price of a security will drop.
All the investors invested using margin accounts, making their strategy particularly risky. Five different customers agreed to continue this strategy even as bond prices rose but instructed their broker to execute transactions that would limit their losses and cover the short positions once treasury bonds reached a certain price. The broker failed to do so, and as a result, FINRA fined the broker $5,000 and suspended him for one month.
How Do Firms Catch Failures of Best Execution?
Firms can either perform an order-by-order analysis or conduct regular and rigorous reviews to determine if they are complying with FINRA’s best execution rules. If firms fail to comply, their customers may be able to recover their losses through FINRA arbitration. If you discover your broker has faced investor allegations regarding their failure to execute, contact Kurta Law for a free case evaluation.