Notice and Transparency

Notice and Transparency

Background

One of the key requirements related to Best Execution, is “the delivery of appropriate notice to the customer, at or before the completion of any transaction in any security for or with the account of a customer; written notification (confirmation) in conformity with the requirements of SEC Rule 10b-10”. This complements the requirements of FINRA’s Rule 6600 series. Of the many component requirements necessary to be included in the customer’s confirmation, is the statement informing the client of the broker’s participation in POF practices as defined in SEC Rule 10b-10(d)(8). The notice need NOT specifically state the amount of POF received, if any; however it must be disclosed upon request of the customer
Another notice requirement also directly tied to Best Execution, is the mandatory requirements of SEC Rule 606 and FINRA’s Rule 5310 which specifically demand that a broker, reveal to its customer its routing choices for order execution and their performance related to “order handling” and “best execution”; and more specifically the amounts of Price Improvement received on an overall basis for different categories of orders as described in the rules.

Transparency is not only critical to Best Execution and its Price Improvement and Payment for Order Flow components; its overall importance extends to almost every aspect of a broker-dealers relationship with its customers. It begins with the sharing of information as required and defined in the opening of an account and the individual customers’ account profile. “Know your Customer”, “Suitability” and “Best Execution” are all dependent on full transparency by all parties, if there is to be genuine relationships founded on the knowledge and trust that transparency engenders.
Virtually all of the regulatory compliance requirements are predicated on transparency. That transparency also extends to the successful relationship of the broker-dealer with its regulators. It is incumbent a broker-dealer to provide the regulators current and actual financial information, the firm’s compliance with hardware, software and network infrastructure requirements. This also extends to their human capital resources, their registration and continuing education requirements, not just for associated persons, but all employees of the firm.

Analysis

Irrespective of the SEC and FINRA rules requiring  notice of POF practices, the notice requirements do not specifically state where on the confirmation the notice must be stated. For most broker-dealers, the industry practice has been that these POF notices are on the back of the confirmation, and are in no way highlighted to make the customer fully aware of the practice, which seemed to be the case with Robinhood’s confirmation practices. The requirement also does not require a specific statement of receipt of POF, so much as the use of the terminology “May Receive” additional compensation for POF;  the actual amount received for a specific order execution, to be provided only if specifically requested by the customer. This failure to emphasize Price Improvement opportunities or prominent Notice of Payment for Order Flow, was deemed a major component of the regulatory complaints.

The regulators, in their complaint allegations and the AWC settlements, seemed to surprisingly focus less on the actual “POF Confirmation Notice”, so much as the failure of both Robinhood and the clearing broker’s requirement to provide the necessary and appropriate reviews of Best Execution; especially in view of the “availability of payments in return for order flow commitments may influence the evaluation by a broker-dealer of the most advantageous market or market maker to whom to route the order”. Rather their emphasis was on FINRA Rule 600 series and the SEC Rule 606. Robinhood’s notices were deemed incomplete and not compliant with the requirement to provide the customer with the comprehensive regular and rigorous reviews of specific components subject to their (Robinhood) review and published notice requirements; to be presented for their clients own assessment as to information demanded by the regulators; not the least of which was PI opportunities, success rates related to the Robinhood’s choice of a reasonable and appropriate choice of routing destinations and best execution performance.

It is obvious from the allegations stated in the customer and regulatory complaints as well as the AWC settlements, that Robinhood was derelict in many areas of their Transparency requirements. Their failure to appropriately comply with their Best Execution requirements and its components for Price Improvement, Payment for Order Flow and their review requirements as defined in both FINRA and SEC review and notice obligations, set out in the regulatory demands harmed their clients. Robinhood customers were entitled to notice that would provide the transparency necessary for their clients’ evaluation of trust and confidence in Robinhood; and their ability to assess the competency and dedication to their (the customer) best interests.

Robinhood’s conduct also failed to meet the demands of their (Robinhood) regulators. Transparency is a critical component of FINRA’s mandate to provide the necessary information to appropriately surveil and comply with their (FINRA & SEC) “Self Regulatory” efforts and compliance by their members. There needs to be a mutual trust that both broker-dealers and the regulatory authorities are all committed to an informed and knowledgeable public and congressional legislative mandates. Dialogue is critical to effective transparency between customers, brokers, and regulators.

Recommendations

Despite the AWCs lack of emphasis on the Confirmation Notice, my experience with participation in POF practices and their being subject to ongoing clouds of controversy, I would recommend that most firms would benefit from less regulatory scrutiny if POF notices were made more prominent.  Placing the notice on the front of the confirmation in equal type size would be my preferred approach. Alternatively, should senior management and the CCO decide that the notice remains on the back of the confirmation, the use of bolder, if not greater type size should suffice. 
The requirement for providing a comprehensive review of best execution, inclusive of all specified components of that review, as provided for in Regulatory Notice requirements as set out in FINRA Rule 600 series, SEC Rule 10 b-10 and Rule 606,  should be subject to rigorous reviews by compliance personnel on a regular basis with reasonable diligence. The focus being on Price Improvement Opportunity as well as the actual delivery of those benefits, irrespective of any POF agreements. Senior management must demand the same of their clearing broker, along with both their involvement in order routing decisions to executing venues that provide the best overall performance for the benefit of their customers. The Chief Compliance Officer, must oversee the compliance with the requirements and practices, not the least of which would be an increased emphasis on the frequency of published notice.

Robinhood’s initial remediation effort to provide greater Transparency, should include direct outreach and interactive communications with their clients. This is not just product marketing, but actual product education. Robinhood clients need to  provide greater efforts to inform their clients. At a minimum their customers must receive appropriate and comprehensive data, as required by both FINRA and SEC regulations. Robinhood clients need to be given timely and accurate notice of any actions and practices that may better inform their customers. This should not only be for actions by their customers, but also for information related to markets in general, but also for subjects and events that enhance the client’s knowledge and expectations related to their overall relationship with Robinhood.

Robinhood must also increase their interaction with their Regulators, as to their intentions and compliance efforts with regards to their policies and practices that may reflect on their (Robinhood) customers. This openness and intention to engage, clarify and maintain an ongoing dialogue with regulators, should result in greater knowledge and capabilities for Robinhood and their clients. It Is also important for regulators to respond promptly to broker-dealers and their customers’ queries.

There must be an emphasis on plain language to guide broker-dealers and their public investors on behalf of the Commission’s Transparency efforts. Broker-dealer efforts to establish an effective  “Culture of Compliance” are predicated on a willingness to provide frequent and comprehensive “transparency.” 

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