FOR IMMEDIATE RELEASE 99-146 Chairman Arthur Levitt Stresses Need for Best Execution in Light of Findings From Ongoing SEC Review Calls on Brokers To Improve Practices and Disclosure; Asks Media To Help Educate Public Boca Raton, Florida, November 4, 1999 -- As part of his continuing discussion of the great technological, competitive, and structural changes sweeping the securities markets, Securities and Exchange Commission Chairman Arthur Levitt today stressed the importance of best order execution and called on brokers to improve their order execution practices and disclosure. The Chairman's remarks were delivered at the Securities Industry Association's annual meeting in Boca Raton, Florida. Chairman Levitt said that best execution is part of the four- pronged framework that has guided the securities markets since 1975 and will help to achieve a true National Market System. The other three elements are: competition among markets; transparency of pricing; and linkages between market centers. Chairman Levitt commended those brokers who strive to ensure that their customers receive quality execution. "However," he said, "the duty of best execution is being neglected by those who fail to carefully review their order routing arrangements. I worry that best execution may be compromised by payment for order flow, internalization, and certain other practices that can present conflicts between the interests of brokers and their customers." Chairman Levitt made the following key points: * SEC review of best execution finds that payment for order flow is affecting which markets orders are sent to; * Payment for order flow disclosure is not helpful for investors; * Best execution must be a priority as options markets link; * Nasdaq unified opening is both possible and long overdue to avoid scattered pricing; * Decimalization will create profound challenges to best execution; * Improved dialogue and disclosure needed; * Financial news media can help inform investors on firms' order execution quality; and * SEC issues best execution guidance to investors on website. What is Best Execution? Best execution encompasses a number of factors starting with the price of the execution and the opportunity for price improvement. Other factors include speed and likelihood of execution. For institutional investors, anonymity and liquidity might be overriding concerns. To discharge in a meaningfully way its best execution obligation, a firm must consider and analyze execution alternatives without regard to the firm's own economic self-interest. Best Execution Review Findings Are Troubling Chairman Levitt said he was troubled by some of the preliminary findings from an SEC review of how firms are complying with their best execution obligations. He said that while payment for order flow is legal, some firms appear to be allowing such payments or other inducements to affect which markets they send their orders to -- at the expense of quality executions. Chairman Levitt said, "Some firms, for example, have told us that execution speed is the most important factor in their routing decisions. But some of these firms have not conducted a regular and rigorous review of execution alternatives -- reviews to determine whether there are other places that offer faster executions, or executions that are just as fast but with a greater likelihood for price improvement. These firms also offer no support for their belief that their customers prefer speedy execution above all else. Sometimes, the invocation of speed rings as a hollow rationalization for selling order flow or capturing the spread on internally executed orders." The SEC review also found encouraging practices, including firms that ask the different market centers for execution quality statistics, including speed of execution and percentage of price improvement, and firms that route "test trades" to gather the same data. Payment for Order Flow Disclosure Is Not Helpful for Investors In 1995, the Commission decided to require disclosure of payment for order flow rather than prohibit it. Upon request, an investor has a right to know how his broker is typically paid for executing a trade; to know whether his broker receives a payment for sending an order to a certain exchange; and to know if his broker has a profit sharing arrangement with a market center. Chairman Levitt said, "Unfortunately, today's payment for order flow disclosure, while factually accurate, is just not clear to investors. The typical disclosure does nothing more than list the variety of compensation arrangements that may result when a broker is paid for customer orders... It's like turning to a weatherman and having him tell you it may rain today, but then again, it may not." He added, "The potential harm of conflicts between the interests of brokers and customers extends beyond the broker-customer relationship. Whether it's payment for order flow, internalization, reciprocal arrangements of any kind, rebates, or discounts, all of us must insist on the best possible execution of a customer's trade. Anything less undermines the power of competition -- the backbone of vibrant markets." Best Execution Must Be Priority as Options Markets Link Chairman Levitt said that increased competition in the options markets has made the duty of best execution even more critical. He said, "Linkages, designed and implemented to facilitate best execution, must be these exchanges' foremost priority. Swift and certain progress towards the establishment of trade rules preventing inferior executions, and the prompt display of limit orders, are immediate necessities." Chairman Levitt also sounded a note of caution about troubling signals coming from the options markets. He said, "Some seem intent on introducing externalities -- payment for order flow and internalization -- into the options markets. I see the reports of joint ventures between options order flow providers and options specialists where profits on order flow are to be shared. Rest assured, we will guard the promise of a competitive, free and fair options marketplace." Execution Quality at the Market Level Chairman Levitt noted that market centers -- including ECNs -- also have a responsibility to monitor their price setting functions. He said, "The NYSE, in many respects, has been and remains a standard setter in the area of price improvement. And currently Nasdaq is exploring promising ways to promote greater interaction among customer orders." He continued, "But there is room for improvement. One example comes to mind: Nasdaq's opening period. Today, widely disparate prices sometimes prevail during this period, compromising the quality of executions that some investors receive. Chairman Levitt said that a unified opening on Nasdaq is both possible and long overdue. He said, "I am happy to report to you today that the NASD has committed to address this problem recently. The Quality of Markets Committee has made this a top priority. We will hold them to this pledge. All markets must continue to guard the integrity, and continually enhance the technology of their pricing mechanisms." Decimalization Will Create Profound Challenges Chairman Levitt said that best execution will be reshaped by the advent of decimal pricing. "As spreads narrow, some are asking whether searching for a penny of price improvement serves the average retail investor's interest? Will the significance of price improvement increasingly depend on the size of the trade or the spread involved? Should the notion of materiality serve as the touchstone for brokers as they evaluate customer preferences? Should brokers be able to step ahead of a customer's order with a penny's price improvement and, if so, will this reduce the incentive to enter limit orders?" Chairman Levitt added, "Now is the time for all market participants to contemplate, to consider, to prepare as best we can for the impact that decimalization will have on our markets." Better Dialogue and Disclosure Needed, Not Rulemaking Chairman Levitt said that the many complaints and questions the SEC receives from investors regarding execution quality demonstrates the need for better dialogue and disclosure. But, he said, "Now is not the time for rulemaking regarding order execution. We must not enter the millennium handcuffed by potentially cumbersome, and perhaps even soon outdated restrictions. But future uncertainties should not put the duty of best execution on hold." The Chairman asked the firms to take several steps: begin a more meaningful dialogue with their customers about the execution of their orders; think about distributing voluntary, plain English reports to customers illustrating their track records for execution in a quantifiable and meaningful way; make execution protocols -- standards for handling customer orders -- available to the public; and let investors know what is emphasized -- speed certainty, the opportunity for price improvement, or something else. Financial Media Needed to Help Educate Investors Chairman Levitt called on the financial news media to help educate investors about best execution by including execution quality in reviews of retail brokerage services. He said, "Best execution is every bit as important as commission rates. Most firms already track their average speed of execution and average percentage of price improvement. A simple, comparative analysis of these factors, along with a description of competing firms' execution protocols, is an easy and important first step." Best Execution Guidance on SEC Website Chairman Levitt said, "The appetite of retail investors for financial information has far surpassed what any of us in this room would have predicted just a few years ago. Let's not squelch that appetite for information -- let's help feed it." To that end, the Chairman announced that the Commission published on its web-site today guidance that explains the basics of order routing, payment for order flow, and internalization. The Commission's web site is www.sec.gov. He also encouraged investors to look beyond commission costs and ask their brokers for the details of any payment for order flow arrangements. # # #