Rule 5310. Best Execution and Interpositioning

(a) Best execution standard.

In any transaction for or with a customer or a customer of another broker-dealer, a member and persons associated with 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. Among the factors that will be considered in determining whether a member has used "reasonable diligence" are:

1. The character of the market for the security (e.g., price, volatility, relative liquidity, and pressure on available communications); 2. The size and type of transaction; 3. The number of markets checked; 4. Accessibility of the quotation; and 5. The terms and conditions of the order which result in the transaction, as communicated to the member and persons associated with the member.

(b) Interpositioning.

Failure to maintain or adequately staff an over-the-counter order room or other department assigned to execute customers' orders cannot be justified on grounds of cost savings to the member. In any transaction for or with a customer, no member or person associated with a member shall interject a third party between the member and the best market for the subject security in a manner inconsistent with paragraph (a) of this Rule.

(c) Scope.

Paragraph (a) applies to transactions in all securities, including equity securities (NMS stocks and OTC equity securities), options, debt securities (including municipal securities, with the MSRB's parallel rule providing the operative standard for transactions subject to MSRB jurisdiction), and foreign securities. The particular factors that shape "reasonable diligence" vary by asset class and market structure.

(d) Customer orders routed to another broker-dealer.

A member that routes customer orders to another broker-dealer for execution on an automated, non-discretionary basis must regularly and rigorously review the execution quality provided by the broker-dealers to which the member routes orders to satisfy the requirements of paragraph (a). A member that relies on the executions provided by another broker-dealer does not thereby shed its best-execution obligations; it retains them and must supervise its counterparties.

Supplementary Material

.01 Application of Best Execution Obligation.

The obligations of paragraphs (a) and (b) apply regardless of whether the member is acting as agent or as principal in the transaction. Where the member is dealing with another broker-dealer — whether in the over-the-counter market or on an exchange — best-execution obligations continue to attach to the member with respect to its own customer. A member may not claim "principal discretion" as a means of circumventing paragraph (a).

.02 "Regular and Rigorous Review."

A member that routes customer orders to other broker-dealers (whether for execution on an agency basis, on a net basis, or as principal) must conduct a regular and rigorous review of the execution quality likely to be obtained from the different markets trading the subject security. "Regular and rigorous" review:

- Should be conducted on a security-by-security, type-of-order basis (e.g., limit order, market order, and market on open or close) and on an order-size-by-order-size basis; - Must consider, at a minimum, the following factors: (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); (ii) differences in price dis-improvement (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); (iii) the likelihood of execution of limit orders; (iv) the speed of execution; (v) the size of execution; (vi) transaction costs; (vii) customer needs and expectations; and (viii) the existence of internalization or payment for order flow arrangements; - Must be documented, with findings, conclusions, and any changes in routing practices or venue selections made as a result, retained in accordance with the member's recordkeeping obligations.

At a minimum, the review must be conducted on a quarterly basis. More frequent reviews may be required where the volume or volatility of routed orders justifies it, or where execution quality statistics show material deterioration at a particular venue.

.03 Scope of Review.

The "regular and rigorous" review must encompass the universe of venues used by the member, not merely a sample. Where a member routes a portion of its flow to a particular venue that is trivial in the aggregate, the member may take a risk-based approach to scoping its review, but must document the basis for doing so.

.04 Handling of Orders That Are Executable at More Than One Exchange.

When handling a customer market order where the subject security is quoted at the same price on more than one exchange or market center, a member must have policies and procedures reasonably designed to obtain the most favorable terms reasonably available, taking into account the factors enumerated in paragraph (a).

.05 Execution of Marketable Customer Limit Orders.

A member that holds a customer limit order that is executable against a contra-side order held by the member must provide the customer with an execution price at least as favorable as the best prevailing bid or offer when the customer order is received.

.06 Internal Review Committee.

A member should establish an internal committee, or otherwise designate persons, responsible for:

- Establishing and periodically reviewing the member's order-routing policies and procedures; - Conducting the regular and rigorous reviews required under Supplementary Material .02; and - Documenting findings and escalating issues to senior management.

The committee or designated persons should be independent of the business units whose execution quality they review and should include representatives from the compliance, trading, and supervisory functions.

.07 Payment for Order Flow.

A member that receives payment for order flow — whether in cash, rebates, soft dollars, research, or other consideration — must conduct a regular and rigorous review under Supplementary Material .02 that specifically evaluates whether such arrangements impair execution quality. The existence of such payments does not by itself establish a best-execution violation, but the member bears the burden of demonstrating that its routing decisions were made based on execution quality and not on the receipt of payments.

A member that routes a material portion of its customer-order flow to an affiliate, or to a wholesale market maker that provides payment for order flow, must conduct comparative analyses against alternative venues. Where the member's routing decision is influenced by receipt of payments, the member must disclose that fact pursuant to SEA Rule 606 (and, for certain NMS stocks and options, Rule 606(a) and (b)) and must retain records sufficient to demonstrate its best-execution review.

.08 Execution of Customer Orders.

A member that receives a customer order and elects to execute it as principal must do so at a price that is at least as favorable to the customer as the member could have obtained from other market centers. Markups and markdowns must be reasonable under NASD Rule 2121 (Fair Prices and Commissions) / MSRB Rule G-30.

.09 Best Execution for Fixed Income Securities.

For debt securities (corporate, agency, asset-backed, and mortgage-backed) that are subject to FINRA jurisdiction, the best-execution review required by paragraph (a) must be conducted in a manner that accounts for the distinct characteristics of the fixed-income markets, including:

- Limited quotation transparency and the role of trace-reported data as a post-trade reference; - The number of dealers contacted before execution; - The size of the order relative to typical trading size for the security; - The terms, including embedded call features, coupon, maturity, and credit quality; - The trading activity (i.e., whether the security is actively or thinly traded); and - The accessibility of quotations.

Where a member executes a customer's fixed-income order on a principal basis, the member must document the dealer solicitations undertaken, the quotes received, and the rationale for the price provided to the customer.

Interpretations and Staff Guidance

Regular and Rigorous Review — Documentation Expectations

Members have been cited for conducting quarterly reviews of execution quality that consist of a single spreadsheet aggregating top-line statistics from Rule 605 reports across all routed venues. FINRA staff have indicated that such a review is insufficient to satisfy Supplementary Material .02 where:

- The review does not separate the member's order types and sizes; - The review does not examine price improvement or dis-improvement for marketable limit orders against the NBBO at receipt; - The review does not address the member's own payment-for-order-flow arrangements; and - The review does not document conclusions or any changes in routing practices resulting from the review.

Members that route a substantial portion of their retail order flow to wholesale market makers should pay particular attention to price-improvement statistics, which are the principal quantifiable signal of execution quality in a retail-held-order context.

Best Execution for Securities That Are Not Quoted Electronically

For securities that are not quoted on an electronic market (e.g., certain foreign securities, illiquid OTC equity securities, or restricted securities), a member must make a documented, good-faith effort to assess the available market by contacting an appropriate number of dealers or reviewing trade-reported data. The absence of a continuously disseminated two-sided quote does not relieve the member of its best-execution obligations.

Relationship to SEC Rule 605 and Rule 606

Statistics disclosed pursuant to Rule 605 (market-center execution quality disclosures) and Rule 606 (order-routing disclosures) are relevant inputs to a Rule 5310 regular-and-rigorous review but are not themselves a substitute for such a review. Members must evaluate the statistics in light of their own order flow, customer base, and routing decisions.

Interposition of an Affiliate

A member that interposes an affiliated broker-dealer or affiliated market maker between the member and the best market must be able to demonstrate that the interposition is consistent with paragraph (a). Cost savings to the member or its affiliate are not a sufficient justification where the effect is to deprive the customer of a more favorable price reasonably available elsewhere.

Compliance notes for Kestrel Securities

Kestrel Securities is a self-clearing broker-dealer that routes retail market and marketable-limit orders to two wholesale market makers under payment-for-order-flow arrangements. Areas of focus in FINRA's current open examination finding:

- **Cadence**: the Best Execution Committee currently meets quarterly. FINRA staff have suggested that quarterly is the minimum and that Kestrel's concentration of flow at two venues warrants monthly monitoring with quarterly formal review. - **Documentation depth**: the committee minutes identify the venues reviewed but do not capture the evaluation of price improvement versus the NBBO at order receipt. Remediation plan: standardize minutes against a checklist derived from Supplementary Material .02's eight factors. - **PFOF reconciliation**: the committee does not independently reconcile received payments against routed share volume. Remediation plan: require the committee to review a monthly PFOF reconciliation prepared by the controller. - **Exception handling**: when price-improvement statistics deteriorate for a given venue by more than a defined threshold, the committee should be able to produce a written rationale for continuing to route to that venue or a documented change in routing. Kestrel's policies do not currently specify the threshold; drafting a numerical trigger is part of the current remediation plan.