Proposed Regulation Best Execution: SEC Considers Market Structure Shakeup

January 2023

The US Securities and Exchange Commission (SEC) proposed Regulation Best Execution (Proposal or Proposed Regulation Best Execution) under the Securities and Exchange Act of 1934 (Exchange Act) to enhance the existing regulatory framework around best execution for brokers, dealers, government securities brokers, government securities dealers, and municipal securities dealers (collectively, Broker-Dealers). The Proposal was released December 14, 2022, alongside three other proposals covering a wide range of market structure issues in the equity markets (Equity Market Proposals).

Although Proposed Regulation Best Execution would apply to a Broker-Dealer’s execution of all types of securities—including digital asset securities—the data and additional requirements that would result from the Equity Market Proposals (if adopted) will factor heavily into how a Broker-Dealer will meet its best execution obligations under the Proposal with respect to equity transactions.

The comment period for Proposed Regulation Best Execution will remain open until the later of March 31, 2023, or 60 days after the applicable proposing release is published in the Federal Register. As of the date of this report, the Proposal has not been published in the Federal Register.

Key Takeaways

  • Broker-Dealers would need policies and procedures that explicitly demonstrate how the Broker-Dealer will (1) obtain and assess reasonably accessible information concerning relevant markets; (2) identify material potential liquidity sources; and (3) incorporate these liquidity sources into their order handling practices and have access to them.
  • Additional measures and documentation would be required for the following types of “conflicted” transactions: (1) principal (including riskless principal) transactions; (2) transactions with affiliates; and (3) transactions involving the receipt of payment for order flow.
  • Broker-Dealers would need to review execution quality at least quarterly.
  • Annual reviews and reports would have to be provided to the board of directors or equivalent.
  • The SEC is placing a heavy emphasis on executions at the midpoint of the best bid and offer.
  • Broker-Dealers would be expected to consider a wide variety of markets and data points when meeting their best execution obligations while simultaneously being mindful of price dis-improvement.
  • The proposed rules include an exception for introducing brokers, but introducing brokers would still have significant obligations to oversee their clearing or executing brokers.
  • The Proposal (along with the Equity Market Proposals) may ultimately spell the end of payment for order flow (PFOF) as we know it, and potentially impact the use of money market mutual funds in sweep programs.
  • The SEC is proposing Regulation Best Execution pursuant to, among other provisions, the anti-fraud provisions of Section 15(c) of the Exchange Act.
  • Broker-Dealers will be required to comply with the stricter best execution requirements of either Proposed Regulation Best Execution or those of an applicable self-regulatory organization (SRO): the Financial Industry Regulatory Authority (FINRA) or the Municipal Securities Rulemaking Board (MSRB).