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August 11, 2008

Fined Scottrade Looking Hard at Execution Quality

By Peter Chapman

Scottrade is taking best execution seriously these days. The discount brokerage, which was recently fined about $1 million by the Securities and Exchange Commission for lapses in the oversight of its routing practices, informs customers on its website that it conducts a "regular and rigorous review of execution quality" in its trades.

The firm first started informing customers of its policies in August 2006 when it noted the development of its Scottrade Best Execution Index (SBI), used for evaluating execution quality on a stock-by-stock basis.

Scottrade didn't always perform a "regular and rigorous review," according to the SEC, at least in some instances. The regulator fined Scottrade in June for failing to adequately review its executions in pre-opening Nasdaq trades during the four-year period between January 2001 and December 2004. Specifically, Scottrade did not take into account the possibility of getting price improvement on these orders when routing them to industry trading desks for execution, the SEC alleged.

In December 2000, the regulator had advised order sending firms to take into account the services of those trading firms offering fills in Nasdaq stocks between the national best bid and offer at the opening. Knight Capital Group and Schwab Capital Markets (now UBS) both began offering the service in 2000. The SEC says Scottrade ignored its advice.

During the period in question Scottrade sent the bulk of Nasdaq orders over which it had routing discretion to Knight, Herzog, Heine, Geduld or to its own trading desk, according to filings with the SEC.

Now Scottrade sends about two-thirds of its non-directed Nasdaq orders to Knight, with the balance split evenly between Citadel and ATD/Citi. The broker says it monitors execution quality at all the venues to which it sends orders. It looks at daily order-by-order exception reports. It also conducts a regular and rigorous review of trades after the fact by analyzing data from Thomson Analytics (formerly Market Systems) and its own SBI. The SBI is used to compare execution quality at the market centers used by Scottrade with that attained by other market centers. It is a tool for identifying underperforming venues, Scottrade says.

Scottrade settled the case without admitting or denying the findings. In a statement, it said: "Since 2004, changes in Nasdaq market structure and new procedures by Scottrade have rectified the issues addressed in the Order. Our customers' satisfaction remains our top priority."

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