Written by attorney Debra G. Speyer

Investor FAQ: How Do Brokers Buy and Sell Stock?

At Wall Street Fraud, we strongly believe that education is one of the best defenses against stockbroker fraud. Therefore, we want to provide our readers with a brief overview of how stockbrokers execute an order to buy or sell stock. In particular, it is important for investors to understand the duty of “best execution."

Investors must first understand that orders to buy or sell stock are not executed instantaneously. In fact, SEC regulations do not require a trade to be executed within a set period of time. However, if firms advertise their speed of execution, they must not exaggerate or fail to tell investors about the possibility of significant delays.

Another important fact is to understand is that your broker generally has a choice of markets in which to execute your trade. For instance:

  • For a stock that is listed on an exchange, your broker may direct the order to that exchange, to another exchange, or to a firm called a “market maker." These firms stand ready to buy or sell a stock listed on an exchange at publicly quoted prices. To generate business, some market makers will pay your broker for routing your order to them. This is called “payment for order flow."
  • For a stock that trades in an over-the-counter (OTC) market, your broker may send the order to an “OTC market maker." Many OTC market makers also pay brokers for order flow.
  • Your broker may route your order to an electronic communications network (ECN) that automatically matches buy and sell orders at specified prices.
  • Your broker may decide to send your order to another division of your broker’s firm to be filled out of the firm’s own inventory. This is called “internalization."

The various choices above lead us to the duty of “best execution," mentioned at the beginning of this post. 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 ECNs offer the most favorable terms of execution.

The opportunity for “price improvement" is an important factor a broker should consider in executing its customers’ orders. “Price improvement" is the opportunity, but not the guarantee, for an order to be executed at a better price than the current quote.

Of course, the additional time it takes some markets to execute orders may result in your getting a worse price than the current quote, particularly in a fast-moving market. So, your broker is required to consider whether there is a trade-off between providing its customers’ orders with the possibility, but not the guarantee, of better prices and the extra time it may take to do so.

Finally, in cases where the stockbroker fails to execute the duty of “best execution," he or she may be liable to the client for any investment losses suffered. Therefore, if you are concerned about trades executed by your stockbroker, it is important to consult with an experienced securities fraud attorney.

Source: SEC

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