The SEC has proposed new Regulation Best Execution:
Proposed Regulation Best Execution would require broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to comply with the proposed best execution standard. Further, the proposal would require these policies and procedures to address how broker-dealers will comply with the best execution standard and how they will determine the best market and make routing or execution decisions for customer orders.
The policies and procedures would also be required to address additional factors for conflicted transactions with retail customers. With respect to such transactions, the proposal would require broker-dealers to document their compliance with the best execution standard, including all efforts to enforce their best execution policies and procedures for conflicted transactions and the basis and information relied on for their determinations that such conflicted transactions would comply with the best execution standard. Broker-dealers would also be required to document any arrangement concerning payment for order flow.
For starters, if this goes through, retail investors can kiss zero commission brokerage accounts goodbye. SEC Commissioner Hester Peirce opines that:
I cannot support this proposal, which is unduly prescriptive and seems less concerned about whether customers actually get best execution than if brokers implement a checklist that the Commission itself is not confident will help brokers achieve even better—much less best—execution.
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The proposed rule provides a handy checklist for SEC examiners and enforcement attorneys, but it does not foster brokers’ exercise of judgment to achieve what is best for customers. Best execution cannot be reduced to a checklist. Indeed, a checklist mandated by the Commission invites a culture of check-the-box compliance that does little to improve execution quality. Instead, it may promote broker and regulatory complacency about working creatively to get the best execution possible for customers.
Peirce further explains that institutional investors will also suffer:
Institutional customers arguably do not need the protection of a best-execution rule, particularly one as prescriptive as this proposal. The proposed rule makes price the primary objective of the broker. Institutional investors may have other important objectives, such as speed and minimizing the effect on price. The rule makes it hard for institutional brokers to tailor best execution to a customer’s objectives.
Finally, Peirce sends potential challengers a none too subtle hint about how to challenge the rule:
The release does not take serious account of the potential for increased commissions when it assesses likely changes in execution quality, even though it seems that any estimate of execution quality, particularly in a rulemaking like this, should take the per-share cost of commissions into account. At some points in the release, the discussion hints that a broker-dealer, to meet its requirements under the rule, should convert PFOF into price improvement. Why is withholding price improvement from the customer worse than charging the customer a (likely higher) commission?
As we know, the SEC has lost a number of cases in recent years for doing an inadequate cost-benefit analysis, which seems to be what Peirce is teeing up.
Commissioner Uyeda is also not a fan of the Commission's cost-benefit analysis:
This particular proposal uses the phrase “the Commission believes” 77 times. What does that phrase mean? If the phrase is employed as a reasoned conclusion of the Commission after a discussion of supportive evidence and relevant analysis, then I suppose that is fine. However, when the expression—“the Commission believes”—is employed as a substitute for evidence, like spackling used to fill a hole, then that is a problem. Indeed, “the Commission believes” seems to be used as another regulatory shortcut for situations when the Commission has no hard evidence or data, but nonetheless has a theoretical concern.
