Levitt: Some Brokers Fail to Seek Best Prices

In their rush to pursue moneymaking alliances or to build up their in-house trading businesses, some brokerages appear to be failing to find the best possible deals when executing customers’ stock transactions, the nation’s top securities regulator said Thursday.

Securities and Exchange Commission Chairman Arthur Levitt, citing preliminary findings from a review by SEC examiners, said “quality of execution” is sometimes being sacrificed because of inducements that brokerages receive for directing orders to a particular market or firm for execution.

His remarks, highlighting a theme he has spoken on previously this year, came in a speech at this resort city during the annual meeting of the Securities Industry Assn., the brokerage industry’s chief trade group.

Levitt didn’t name names of brokerages or markets, but he said the SEC is continuing its review and that the issue can only increase in importance as the U.S. markets move toward decimal pricing of stocks next year.

Quality of execution refers to the speed, reliability and price characteristics of a transaction. Sometimes the fastest place to get a trade done doesn’t offer the best possible price, and sometimes the best-price market can’t accommodate more than a handful of orders at a time. All of these factors must be balanced as brokerages strive to get their customers the best possible execution, Levitt said.

One of his top concerns is so-called payment for order flow. Payment for order flow is the legal practice by some stock dealers, or market makers, of paying brokers a fee--typically a penny per share--to attract buy or sell orders that the market maker then executes, or fills.

The SEC, in a 1995 review, could have declared such payments to be kickbacks and simply banned them outright. However, realizing that the practice actually can improve trade execution by giving innovative new dealers a way to compete against established rivals, the SEC opted instead to require brokerages to disclose such payments upon request by an investor.

Levitt defended the decision but said most disclosure currently is ambiguous and unclear to investors. He called on brokerages to do a better job of spelling out the potential conflicts involved in such arrangements.

To protestations that the issue is small potatoes because it typically involves stock price differences of one-sixteenth of a point, or 6.25 cents, Levitt gave this example:

Consider a broker who receives a penny per share inducement from a market maker on a 1,000-share buy order and sends the trade to that firm, even though there’s the possibility of a 6.25-cents-a-share-cheaper price at a competing dealer. Even if the broker passes along his entire $10 payment-for-order-flow rebate to the customer--”unheard of,” Levitt said--the customer still has overpaid by $52.50.

“To an investor, that’s real money,” Levitt said.

Another potential conflict for brokers can be the temptation to send orders “upstairs”--that is, to have them matched against other orders coming into the firm, without sending them to a competing trading floor for the possibility of a better execution. By keeping orders in house a firm can reap the spread between the buy and sell prices.

“To discharge in a meaningful way its best execution obligation, a firm must consider and analyze execution alternatives without regard to the firm’s own economic self-interest,” Levitt said.

The SEC on Thursday published on its Internet site a new guide for consumers titled “Trade Execution: What Every Investor Should Know.” The guide is at https://www.sec.gov/consumer/bestexec.htm.