Best Execution

In SFC's Code of Conduct, "best execution" means when acting for or with clients, the intermediary should execute client orders on the best available terms. In actual world, under what circumstances would this principle be violated?

Last week SEC settled fraud charges against Morgan Stanley & Co. Inc. for its failure to provide best execution to certain retail orders for OTC securities. In particular, Morgan Stanley embedded undisclosed mark-ups and mark-downs on certain retail OTC orders processed by its automated market-making system and delayed the execution of other retail OTC orders, for which Morgan Stanley had an obligation to execute without hesitation.

Morgan Stanley will pay around US$7.9m in disgorgement and penalties to settle SEC's charges. All of Morgan Stanley's revenue from its undisclosed mark-ups and mark-downs will be distributed back to the injured investors through a distribution plan.

From Oct 2001 through Dec 2004, Morgan Stanley failed to obtain best execution for certain orders for OTC securities placed by retail customers of Morgan Stanley, Morgan Stanley DW, Inc. and third party broker-dealers that routed orders to Morgan Stanley for execution. As a result of this conduct, Morgan Stanley breached its duty of best execution with respect to these retail customers' orders.

Morgan Stanley failed to provide best execution to more than 1.2 million executions valued at approximately US$8 billion. Morgan Stanley recognized revenue of $5,949,222 through its improper use of undisclosed mark-ups and mark-downs. As stated by SEC, Morgan Stanley was recklessly programming its order execution system to receive amounts that should have gone to retail customers.