FINRA Alert! Without admitting or denying the findings, from January 2019 through February 2021, Public Investing did not conduct reasonable reviews of the execution quality of its customers' orders or disclose receipt of Payment for Order Flow (PFOF).
FINRA "Punishment"? Censure and $500,000 fine.
Source: https://www.finra.org/sites/default/files/fda_documents/2020065340901%20Open%20to%20the%20Public%20Investing%2C%20Inc.%20CRD%20127818%20AWC%20lp.pdf
FINRA's Best Execution Rule:
Broker-dealers have a longstanding and fundamental obligation to seek "best execution" of their customers' orders-that is, to seek the most favorable terms for their customers' orders that are reasonably available under the circumstances. FINRA codified this best execution obligation in FINRA Rule 5310 and its Supplementary Material. FINRA Rule 531 0(a)(l) provides that, "[i]n any transaction for or with a customer or a customer of another broker-dealer, a member ... shall use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions." FINRA Rule 5310 Supplementary Material .09(a) (Rule 5310.09(a)) requires members to conduct either "order-by-order" or "regular and rigorous" reviews of the execution quality of customer orders:
A member that routes customer orders to other broker-dealers for execution on an automated, non-discretionary basis, as well as a member that internalizes customer order flow, must have procedures in place to ensure the member periodically conducts regular and rigorous reviews of the quality of the executions of its customers' orders if it does not conduct an order-by-order review.
Rule 5310.09(a) requires that firms conduct regular and rigorous reviews, at a minimum, on a quarterly basis and consider whether, based on their business, more frequent reviews are needed. FINRA Rule 5310.09(b) provides that, "[i]n conducting its regular and rigorous review, a member must determine whether any material differences in execution quality exist among the markets trading the security and, if so, modify the member's routing arrangements or justify why it is not modifying its routing arrangements." Each member must "compare, among other things, the quality of the executions the member is obtaining via current order routing and execution arrangements ... to the quality of the executions that the member could obtain from competing markets."
FINRA Rule 5310.09(b) also identifies certain factors that should be considered in reviewing and comparing the execution quality of the member's current order routing and execution arrangements to the execution quality of other markets, including: (I) price improvement opportunities (i.e., the difference between the execution price and the best quotes prevailing at the time the order is received by the market); (2) differences in price disimprovement (i.e., situations in which a customer receives a worse price at execution than the best quotes prevailing at the time the order is received by the market); (3) likelihood of execution of limit orders; (4) speed of execution; (5) size of execution; (6) transaction costs; (7) customer needs and expectations; and (8) existence of internalization or payment for order flow arrangements.
A violation of FINRA Rule 5310 is also a violation of FINRA Rule 2010, which requires members to observe high standards of commercial honor and just and equitable principles of trade in the conduct of their business.
Public Investing failed to meet its best execution obligations:
From January 2019 through February 2021, Public Investing used a smart order router provided by its clearing firm to route customer orders to at least five market makers for execution. The smart order router directed order flow to each market maker according to a ranking system designed by the clearing firm, which considered a variety of factors, including price improvement for marketable orders, fill rates for non-marketable orders, and the amount of payment for order flow provided by the market maker. Public Investing's clearing firm shared with Public Investing approximately 75 percent of the payment for order flow it received for Public Investing customer orders, which totaled almost $42,000 of the more than $52,000 the clearing firm received during the relevant period. During the relevant period, Public Investing's revenue was approximately $668,000.
Public Investing did not conduct any order-by-order or regular and rigorous reviews of its customers' execution quality. Thus, the firm did not consider any of the factors listed under FINRA Rule 53 l0.09(b) with respect to its customers' execution quality. Instead, Public Investing reviewed its clearing firm's quarterly reports prepared pursuant to Exchange Act Rule 606. These reviews were not reasonable because the reports did not provide any data specific to the execution quality received by Public Investing's customers or information comparing execution quality among venues to which the clearing firm routed or competitive markets. The reports did not differentiate between the clearing firm's broker-dealer clients or execution venues but only included aggregate execution quality provided by each of the market makers to which the clearing firm routed orders.
Public Investing also did not conduct any reviews comparing the quality of the executions it obtained to the quality of the executions it could have obtained from competing markets.
Public Investing did not reasonably supervise for best execution:
FINRA Rule 3110( a) requires each member to "establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations and applicable FINRA rules." FINRA Rule 311 0(b) requires each member to "establish, maintain, and enforce written procedures to supervise the types of business in which it engages and the activities of its associated persons that are reasonably designed to achieve compliance with applicable securities laws and regulations" and FINRA rules. A violation of FINRA Rule 3110 also constitutes a violation of FINRA Rule 2010.
From January 2019 through February 2021, Public Investing's supervisory system was not reasonably designed to achieve compliance with its best execution obligations. As described above, the firm lacked a reasonable system for reviewing the execution quality of its existing order routing arrangements or competing markets. In addition, Public Investing's WSPs were not tailored to the firm's business. The WSPs did not address equity trading, even though Public Investing only provided equity trading. Instead, the WSPs addressed best execution obligations for fixed-income securities, which Public Investing did not offer. As such, the procedures did not provide guidance as to how Public Investing should conduct execution quality reviews for its business.
Public Investing failed to disclose its policies regarding the receipt of payment for order flow.
From January 2019 to December 2020, Public did not disclose to its customers upon account opening, or in annual disclosures, that it accepted payment for order flow or explain its policies regarding the receipt of payment for order flow and its related routing arrangements.
โข From February 2021 through October 2021, a page on the firm's website described the benefits of the firm's fractional share trading, but the descriptions were misleading because they omitted the restrictions or conditions associated with such trading. For example, the website page omitted that fractional shares held in a firm account could not be transferred to another broker-dealer and had to be sold if the account was closed.
โข From February 2021 to October 2021, one page of the firm's website omitted risks and limitations of the firm's securities lending program. For example, the website page did not provide that loaned securities might not be covered by the Securities Investor Protection Corporation or that the rights to dividends and other distributions of loaned securities would be received by the borrower.
Punishment?
Censure and $500k fine
TLDRS:
- Public Investing, a brokerage firm, was found to have violated FINRA's Best Execution Rule (Rule 5310) and other regulations over a period from January 2019 to February 2021.
- They didn't conduct reasonable reviews of the execution quality of its customers' orders or disclose the receipt of Payment for Order Flow (PFOF).
- They also failed to supervise for best execution, and their supervisory system was not designed to comply with their best execution obligations.
- These violations are serious because the best execution rule is in place to ensure that customers' trades are executed under the most favorable terms reasonably available.
- Failure to review the execution quality and compare it with other markets can lead to customers getting less optimal trade outcomes.
- Moreover, the lack of disclosure about receiving PFOF means customers weren't informed that their orders might be influenced by the broker's financial interests, which can potentially conflict with the clients' interests.
