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August 31, 1999

Baffled By Best Execution! Price Improvement Rammed Home as SEC Swoops Down on Firms

By Peter Chapman

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  • Baffled By Best Execution! Price Improvement Rammed Home as SEC Swoops Down on Firms
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Bill Yancey thought he was doing everything right.

As the head of Nasdaq trading at Southwest Securities he is responsible for an agency desk that handles orders for the firm's roughly 200 correspondent brokers. He always figured the trades were routed to the appropriate dealers and market centers.

Then came an SEC inspection.

"The SEC was so critical [of the desk]," said a wounded Yancey, referring to the Securities and Exchange Commission's correspondence that followed the agency's inspection of Southwest Securities' best-execution practices. "The [agency] didn't like our price improvement numbers so it questioned our routing decisions."

The inspection of Southwest Securities is part of a broader SEC oversight of best execution practices at retail brokerages that route trades for their customers. And price improvement, one of several major components of best execution obligations, is foremost on the SEC agenda.

Between 50 and 60 firms - many of them online and discount brokers - were contacted or visited earlier this year by the SEC. The agency says it plans to contact more firms.

Some brokerages are describing the SEC inspection efforts as a sweep. The SEC says they are inspections. "A sweep implies a discreet event," a spokesman for the SEC said. "This is an ongoing process. It will continue into next year."

Whatever the name, the SEC activity on best execution prompted many retail brokers to look more closely at their order flow relationships and arrangements.

"The SEC action was a wake-up call for order-entry firms," said Tom Gira, vice president of market regulation at NASD Regulation, the regulatory arm of the National Association of Securities Dealers. "Those who may be routing orders on blind faith will have to be able to document how they make their decisions."

Robert W. Baird & Co., which was not a part of the recent SEC activity, has just begun a study of its routing procedures. "We are reacting to the stories we read in the newspaper," said Susan Labant, a compliance officer at the Milwaukee-based firm. "We are analyzing where our orders are sent and we will make some modifications."

Southwest Securities received a so-called deficiency letter' from the SEC that led it to make changes on its order routing and preferencing arrangements with other broker dealers. (A deficiency letter is a term used to describe SEC correspondence that points out deficiencies in a firm's compliance practices.) "We did move some of our business around," Yancey said.

Apparently, other firms are doing the same or are considering their options. Phil Rapp, senior vice president for marketing and sales at Knight Securities, the largest Nasdaq wholesaler as measured by trade volume, said some of his customers are considering alternative routing arrangements. "There is definitely a little more focus on this issue," he said.


The SEC actions on best execution may be unprecedented.

Best execution compliance is being scrutinized more closely that ever before, according to Ted Karn, president of Market Systems, a Buchanan, Mich.-based firm that analyses stock transactions. What was considered a "regular and rigorous" best execution compliance effort by firms just a few years ago is no longer acceptable, he says.