Massachusetts’ top securities regulator, Commonwealth Secretary William Galvin, launched an investigation recently into charges that brokers were receiving ‘kickbacks’ for routing sales orders to certain stock exchanges. The probe was inspired in part by a recent New York Times op-ed by Jonathan Macey, a Yale law professor, and David Swensen, Yale’s chief investment officer, who claimed that brokers seeking payment for order flows – instead of choosing the exchange with the best prices for their clients – are taking money out of their clients’ pockets. Mr. Macey and Mr. Swensen wrote in a July 18 piece:
Brokers routinely take kickbacks, euphemistically referred to as ‘rebates,’ for routing orders to a particular exchange. As a result, the brokers produce worse outcomes for their institutional investor clients – and therefore, for individual pension beneficiaries, mutual fund investors and insurance policy holders – and ill-gotten gains for the brokers.
Mr. Galvin said in a statement that his office is “looking into the veracity of these assertions.” He stated in an interview that “it’s up to the states to take the lead.” As part of the investigation, he has sent inquiry letters to Charles Schwab & Co. Inc., Scottrade Inc., TD Ameritrade Inc., Fidelity Brokerage Services, E*Trade Securities, Edward D. Jones & Co. and Morgan Stanley & Co., but those letters were not released. Mr. Galvin said in the statement:
Institutional brokers are responsible for placing millions of dollars of average investors’ life savings in their employers’ pension plans, as well as in mutual funds and variable annuities. If financial rebates or kickbacks create a conflict that results in less than the best deal for the investors, this practice must stop. It is the obligation of regulators to have reasonable assurance that the customer is not being harmed, and that is the reason I instructed my Securities Division to begin this investigation.
The Securities and Exchange Commission (SEC) has wrestled with best execution for decades. It’s a topic that doesn’t lend itself to easy solutions, according to Todd Cipperman, principal at Cipperman Compliance Services, because other factors, such as timing and order size, go into calculating best execution. Mr. Cipperman said:
There’s more to execution than price. Often, the lowest commission is not what determines the best execution. Just because they’re paying [a broker] doesn’t mean it’s not the lowest price. It’s a really complicated issue.
This issue, though complicated, has far-reaching implications. Kickbacks aside, brokers, who, according to Department of Labor’s new fiduciary rule, have fiduciary duties to their clients, can be on the hook for not taking proper steps to verify their choice of exchange actually is the best execution. This new investigation is something that lawyers at Beasley Allen will be watching. If you have any questions contact Rebecca Gilliland, a lawyer in our firm’s Consumer Fraud Section, at Rebecca.Gilliland@beasleyallen.com.
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