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March 1, 2000

Quality Control At Mother Merrill: Spending Big Bucks to Obtain Best Execution

By Peter Chapman

Also in this article

  • Quality Control At Mother Merrill: Spending Big Bucks to Obtain Best Execution

Merrill Lynch & Co., facing tougher industry best execution standards, now more closely monitors its Nasdaq traders.

Mother Merrill has built BEAMS, or the Best Execution Analysis and Monitoring System, in collaboration with Fairfax, Va.-based SRA International, which developed the software. Merrill says the system takes data mining technology from SRA, and combines it with trading rules formulated by Merrill.

With NASD Regulation's Advanced Detection System (ADS) monitoring best execution, Merrill has clearly decided it takes a computer to beat a computer. (ADS itself was built by SRA.) SRA is touting the joint Merrill and SRA product to other firms with both partners sharing profits on new sales.

BEAMS' goals are twofold: to alert traders to possible inferior fills and to measure overall trader and market maker performance.

How It Works

BEAMS compares Merrill's orders and executions against the quotes in the market at the time of the fills. BEAMS scrutinizes every trade for fill quality and then notifies traders of any questionable trades. Traders may get alerts up to four times a day. On a disputed trade, the desk must ensure that the customer is made whole, or else must provide a satisfactory explanation on why a fill was fair.

The system will also look at the performance of market makers handling Merrill's outbound agency orders. Merrill executes 125,000 trades on a principal basis and routes a further 25,000 trades to other market makers daily, according to George Lawlor, a trading manager at Merrill.

Merrill already uses periodic reports from the Transaction Auditing Group (TAG) of Northport, New York, to monitor its trades.

But the firm does not think TAG reports will be enough to satisfy NASD Regulations' increasingly strict definition of a "regular and rigorous" review of its best execution trading practices.

"I want to be able to look at every single execution on a daily basis," Lawlor said. "I don't think I can get any more regular and rigorous' than that."

Lawlor indicated that he would drop the TAG reports when satisfied that BEAMS was working as intended.

TAG chief executive Alan Shapiro, said he does not see the introduction of BEAMS as a threat. "There is room for both an internal system and an outside auditor," he said, contending that TAG reports show information that an internal system cannot.

Shapiro said his service provides individual customers with peer-to-peer comparisons. He maintains that TAG could be more regular and rigorous,' but is concerned with dumping more data on firms than they can handle.

Possible Infractions

With BEAMS, traders get alerts for many possible infractions: late fills of both market orders and limit orders; trades executed outside the national best bid and offer (NBBO); missed trades; late display of limit orders; limit order protection; and fills below an agreed upon size. Lawlor said dealing with the four daily alerts shouldn't take too much of a trader's time.