Best Execution

Do you run fast money at a big money shop? Your days go by in a blur...meetings with CEO’s, rubber chicken roadshows, brief conversations with dodgy people, and lame blogs. They all compete for your time.

Oh yeah. You have to buy and sell things from time to time. On a “Best Execution” basis:

In deciding how to execute orders, your broker has a duty to seek the best execution that is reasonably available for its customers’ orders. That means your broker must evaluate the orders it receives from all customers in the aggregate and periodically assess which competing markets, market makers, or electronic communications networks (ECNs) offer the most favorable terms of execution.

Some of the factors a broker needs to consider when executing its customers’ orders for best execution include: the opportunity to get a better price than what is currently quoted, the speed of execution, and the likelihood trade will be executed. SEC

And don’t forget about “price improvement”.

And you don’t even have to pay the brokers. The squeeze is on.

The average broker fee on New York Stock Exchange-listed shares fell to 3.9 cents a share in 2006 from 4.2 cents in 2005. In the late 1970s, that figure was 12 cents. Total U.S. stock commissions fell to $10.8 billion in 2006 from $13.4 billion in 2002, even though trading almost doubled during that time.

Many buyside shops continue to reduce the number of brokers they trade through, not exactly great news for small and mid-cap managers who deal with boutiques and regional brokers day in and out.

How will the smaller guys survive? Will all institutional trading end up at 25 sell side shops and a few dark pools? Commission sharing arrangements are nice in theory...but checks are not always cut from my experiences.

Big brokers stand to gain the most from such changes, says Larry Leibowitz, chief operating officer for U.S. equities at UBS in Stamford, Connecticut. Small brokers will get squeezed out, he says.

``Investors don’t need to trade through 150 brokers,’’ Leibowitz, 46, says. ``They may need them for research, but they can use commission-sharing agreements for that. It’s harder to get best execution from the smaller shops, although some certainly can provide it.’’

Sanford Bragg, president of Darien, Connecticut-based consulting firm Integrity Research Associates LLC, agrees. ``Money managers will continue to consolidate their trading, putting pressure on second- and third-tier firms and benefiting the 12 or so largest trading firms.’’

At The Boston Company, change is already afoot. Brooks says the firm used to deal with 100 brokers. Now, it uses fewer than 50. As commissions sink and money managers get pickier, even the best brokers will be working hard for their money.

I appreciate the spirit of best execution. But it has resulted in a few unintended consequences. For smaller players, getting paid for one-on-one’s and research is harder than ever. I am not convinced their extinction will be good for Wall Street’s eco-system.

But in the end, the Street will adapt.  Schumpeter wins again.

Bank of America, UBS capture Best Stock Prices for Managers
Bloomberg
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The content contained in this blog represents the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. 

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