The SEC is attempting to set precedent and bypass formal rule making with two cases involving best execution of stock trades.
If the agency is successful in appealing two cases, one involving Merrill Lynch and the other Portfolio Management Consultants of Denver, best execution would no longer be defined as simply getting customers the national best bid or offer (NBBO).
There is no formal SEC definition of what constitutes best execution, and with the recent implementation of new order-handling and quote-display rules, enforcement of best execution responsibility has been a touchy subject with firms.
The SEC's enforcement division is appealing an administrative judge's ruling on a case involving Marc Geman, a principal officer at PMC at the time of the disputed trades. The appeal stems from the judge's ruling that Geman, in fact, had provided best execution by giving clients NBBO on their share prices. The Geman case will be heard by the full SEC commission sometime in December, according to Robert Fusfeld, SEC regional trial counsel in Washington, D.C., with a ruling to follow sometime later.
"This is an important case," Fusfeld says. "We expect the commission to give it a thorough review."
The SEC also is appealing a similar case involving Merrill Lynch (Newton v. Merrill Lynch, first heard in the third circuit court) where NBBO also was provided to clients. The Newton case will be heard "in bank," meaning that all federal appellate judges will hear the facts of the case and decide its outcome. No date has been set for those hearings.
As for whether the commission is using case law to set formal rules, Fusfeld says, "The commission certainly has the option to use enforcement case mechanisms to issue guidance as to what's appropriate or not. They also have the option to set rules."
Both cases involve broker/dealers acting as principals in handling customer transactions. Because both firms in these cases also were fiduciaries (investment advisers in a wrap-fee program), they were under an implicit fiduciary duty to achieve best execution. Under SEC and SRO rules, broker/dealers also are under obligation to provide the best price.
In its appeal of the Geman case, the SEC says that the "best net price" should be obtained when carrying out trades. The SEC is claiming that best execution is the "best price available in the market." This is not necessarily NBBO; traders often can get better prices through alternative markets like Instinet.
In its settlement last summer with the NASD, which included charges of Nasdaq price collusion, the SEC alleged market makers were colluding to keep Nasdaq NBBOs artificially wide, while in many cases laying off the other side of trades on Instinet at prices inside the NBBO.
Merrill Lynch refused to comment on the case. Geman could not be reached.