ABCs of Trade Execution

by Admin Istrator | November 12, 2021 7:35 pm

ABCs of Trade Execution

If you’re a small investor with a Robinhood account, you are probably accustomed to selling shares of GameStop, AMC, Coca Cola and Blackberry in what seems to be the blink of an eye. This is likely to give you the impression that your online broker is directly connected to the securities markets and executes the trades on your behalf. You may be surprised to find out this isn’t how it actually works. What really happens is that your broker, online or in person, will decide how the trade will be executed after it’s placed. A live broker will make this decision himself and online brokers will use algorithms to choose an execution method. Either way, this decision can impact the price you end up paying for your securities. That’s why your broker has a duty to make sure that your order is executed in a manner that’s most likely to get you the best price. If you’ve lost money because your broker hasn’t been getting you the best possible price, you may have a claim for money damages as compensation for your financial loss – contact us[1].

Your Broker’s Choices For Executing Your Orders

Your broker has choices about where to send your order for execution. It can be sent directly to the exchange itself, such as NYSE or Nasdaq, to another exchange such as a regional exchange or to a business called a “third market maker” that buys and sells stocks at publicly quoted prices. “Third market makers” sometimes pay brokers a fee for each order that’s sent their way that’s called “payment for order flow.” This is especially likely to occur for “limit orders” to buy or sell a stock for a specific price. Another option is for the broker to route the transaction to be filled through their firm’s own inventory, making money on the spread between the purchase price and the sales price. The choice your broker makes can have an impact on the price you pay to buy or sell stock, which can substantially reduce your profit. For example, if your order to sell 1,000 shares for $10 a share is delayed, causing the price to drop to 9.90 a share, you would lose $100 on this transaction.

The Duty of Best Execution

The duty of best execution[2] requires brokers to choose the market that is most likely to get you the best price, without regard to how it impacts the amount of money they make on the transaction. It’s allowable for brokers to accept “payment for order flow” from “third market makers,” but choosing to route an order through a particular market due to the payments violates their duty of best execution. In the above example, you lost $100 because your sale was delayed and the price dropped by ten cents a share. The fact that the price dropped before the sale was executed doesn’t necessarily mean that your broker violated the duty of best execution because the market he chose might still have been the best available. He would only be liable for violating the duty of best execution if he knew or should have known that the market he chose processed orders slowly and chose it anyway. If the slower market was making “payments for order flow,” it would infer that’s why he made the choice. If you suspect that you’re losing money on trades because your broker isn’t making the best choices, you should speak to an experienced investor advocate attorney about making a claim.

Securities and Exchange Commission (SEC) Oversight

The SEC knows that most investors are not aware that brokers choose markets, that their buying and selling price is impacted by this choice, that brokers are paid for order flow and that brokers have a “duty of best execution.” That’s why they require all the market centers that are involved in trading securities on the national market system to make electronic disclosures. The SEC requires monthly information from each market center that details the quality of their executions, specifically the effective spreads between what’s quoted and what’s paid to investors at a particular market center. They must also disclose how often their executions are better than public quotes for limit orders. Brokers are required to make quarterly reports that disclose the identity of each of the market centers where they route a significant amount of their orders. They must also respond to requests from customers that request an accounting of where their particular orders were routed for execution during a six month period. This evidence can be used to prove that you’ve lost money because your broker breached their duty of best execution by failing to choose the best market for your orders. You can also request this information from brokerage firms to help you choose one that makes getting the best prices for customers a priority.

What Can I Do If My Broker Breaches His Duty Of Best Execution?

In March, 2021, a class action lawsuit was filed against Robinhood[3] claiming that the company was able to offer “commission-free investing” because it was making money from kickbacks from markets. The plaintiffs claimed that the hidden cost of not getting the best prices cost them more money than what they would have paid in commissions if they had traded with a competitor. They also claimed that Robinhood went out of its way to conceal its practice of routing orders to a group of trading firms in exchange for compensation.

Endnotes:
  1. contact us: https://mdf-law.com/contact/
  2. duty of best execution: https://mdf-law.com/understanding-the-duty-of-best-execution/
  3. Robinhood: https://mdf-law.com/robinhood-complaints/

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