FINRA Rules Related to Order Entry & Execution Practices

Instructor: LeRoy Rands

Bill has taught college undergraduate and MBA classes in finance, economics & management, 40 years of finance experience and has a MBA degree.

There are many methods by which an investment order can be processed by a broker receiving an order. FINRA has requirements as to how market orders and limit orders are to be recorded and processed by the broker receiving the order.

Execution of Investment Orders

George is a broker at XYZ Financial. He has a number of customers who either send him orders online by using XYZ's website or who call him to give him orders. He is required to fill these orders to the best advantage to the client and as fast as he can.

The Financial Industry Regulatory Authority (FINRA) is a non-profit agency who oversees the U.S. investment broker/dealers who manage accounts for the investment public. FINRA establishes rules governing how brokers handle investment orders from clients. This lesson deals with those requirements.

George is aware that orders aren't automatically done when an investor places an online order. George must take the order and figure out the best way to fill that order that will be the best for the customer. Helen, one of George's customers, wants to buy 1000 shares of Apple common stock.

Order Execution Methods

Orders from investors can come in two forms. An investor can put in a market order, which means that the broker buys or sells the securities based on the best price he can get for the investor. However, investors can also put in a limit order, which dictates what price the customer will accept, i.e., he won't pay more than a certain price of a stock or won't sell his stock for less than a certain price.

George has some options as to how to execute a trade and can choose which option will be the best for the customer.

The options available for executing a trade include:

  1. George can send an order to the floor of the stock exchange where the security is traded. In the case of Helen's order, Apple is traded on the New York Stock Exchange, so George could just sent the order to the NYSE floor to be executed.
  2. He could send it to a third market maker. George might send it to another broker when that broker is providing an incentive for George to send him business or if XYZ is not a member of the exchange where the security is actively traded.
  3. XYZ might have some internal inventory of Apple stock. George could choose to fill Helen's order from that inventory. He might do that at the current quoted price for Apple stock even though XYZ might have bought it for inventory at a lower price. George would have to show in the documentation to FINRA why this is the best option for Helen especially if XYZ is making a profit from selling their inventory to Helen.
  4. He could use an electronic communication network (ECN), which automatically matches buy and sell orders for the same amounts to execute trades. This works particularly good for limit orders.
  5. In the case of stocks traded in over-the-counter markets like NASDAQ, George might have to send an order to the market maker whose job it is to promote that security and make a market in it.

FINRA rules and the law require George to give his customers the best possible outcome for the execution of their investment orders. Since all the details of every order need to be documented and substantiated, George knows that if he doesn't do what is best for his customers he could could get into trouble with the regulators.

FINRA Rule 5290

FINRA Rule 5290 stipulates that customer orders cannot be broken into smaller pieces to be processed. This rule was passed to prevent brokers from making multiple orders out of one order in order to make more commissions or fees from processing several orders.

As an example, George needs to process Helen's order for 1000 shares of Apple stock as one order. He cannot break it up into four orders of 250 shares each or he would be in violation of FINRA Rule 5290.

Securities Futures

FINRA Rule 4551 requires brokers to maintain and preserve certain information when they are using an alternative trading system for executing securities future trades. An alternative trading system is not regulated as a trading exchange but is a system to match buy and sell orders of investors. In the U.S., they are called electronic communication networks (ECN) and are maintained by brokers to facilitate trades.

If George is using an ECN to make a futures trade, under Rule 4551, he must collect the following information and ensure that it is saved and preserved:

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