MSRB Rule G-18, the new best-execution rule for municipal securities, became effective March 21, 2016. At this point, most broker-dealers registered with the Municipal Securities Rulemaking Board (“MSRB”) have implemented written policies and procedures for seeking best execution on customer orders in municipal securities. Now, if you are a compliance officer or municipal securities principal at one of these broker-dealers, you may still be pondering precisely how your firm is going to perform and document the required periodic reviews of its best-execution policies and procedures. Many introducing broker-dealers hope to avail themselves of a provision in Rule G-18 that seemingly permits them to rely on the best-execution reviews of their clearing firms. In this blog post, we identify the conditions for obtaining this relief and discuss some of the challenges of relying on another broker-dealer’s best-execution reviews.


The MSRB adopted Rule G-18 to bolster existing fair-pricing standards and to target the process by which broker-dealers handle customer orders and execute customer transactions. Rule G-18 is similar to FINRA’s best execution rule, but it has been tailored to the characteristics of the municipal securities market. Rule G-18 requires a broker-dealer to use reasonable diligence to ascertain the best market for the subject security and buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. Rule G-18 contains a non-exhaustive list of factors that a broker-dealer must consider when exercising “reasonable diligence”:

  1.  the character of the market for the security;
  2.  the size and type of transaction;
  3. the number of markets checks;
  4. the information reviewed to determine the current market for the subject security or similar securities;
  5.  the accessibility of quotations; and
  6. the terms and conditions of the customer’s inquiry or order, including any bids or offers, that result in the transaction.

Requirement to Have Written Policies and Procedures

Rule G-18 requires a broker-dealer to have written policies and procedures for seeking best execution on its customers’ municipal securities transactions. Rule G-18 is designed to be sufficiently flexible to enable each broker-dealer to establish policies and procedures that reasonably reflect the nature of its business, including trading activity, level of sales, and type of customer transactions. Although generally affording a broker-dealer great latitude in establishing its policies and procedures, Rule G-18 specifically requires written policies and procedures for customer transactions involving securities with limited quotations or pricing information.

Mandatory Reviews of Policies and Procedures

It is not enough merely to establish policies and procedures. Rule G-18 further requires a broker-dealer to conduct periodic reviews of its policies and procedures for determining the best available market for the executions of its customers’ transactions. When assessing whether its policies and procedures are reasonably designed to achieve best execution, a broker-dealer must take into account several factors explicitly identified in Rule G-18. These factors include:vroot apk

  1. the quality of the executions obtained under its current policies and procedures;
  2. changes in market structure;
  3. new entrants;
  4. the availability of additional pre-trade and post-trade data; and
  5. the availability of new technologies.

A broker-dealer must conduct its reviews at a frequency reasonably related to the nature of its municipal securities business. To comply with the minimum requirements of Rule G-18, a broker-dealer must perform these reviews at least annually.

Reliance on Another Broker-Dealer’s Reviews

Paragraph .08(b) of the Supplemental Material to Rule G-18 allows a broker-dealer to rely on another firm’s periodic best-execution reviews, provided all of the following conditions are met:

  1. The broker-dealer routes its customer’s municipal securities transactions to the other firm and this firm has agreed to handle those transactions as agent or riskless principal for the customer;
  2. The other firm fully discloses the results and rationale of its reviews to the broker-dealer; and
  3. The broker-dealer periodically reviews how the other firm’s reviews are conducted and the results of the reviews.

For an introducing broker-dealer that routes all of its municipal securities transactions to its clearing firm, this provision appears to provide meaningful relief. In practice, though, the introducing broker-dealer may find that it is unable to qualify for this relief because, for example, its clearing firm does not adequately disclose information about its best-execution reviews.

It is important to note that the relief afforded by this provision applies only to the obligation to perform periodic reviews of the policies and procedures. Even if all three conditions are met, the introducing broker-dealer would still have an obligation to establish its own written policies and procedures governing best execution. According to the MSRB, these policies and procedures could reflect the introducing broker-dealer’s reliance on the clearing firm’s policies and procedures for seeking best execution and on the clearing firm’s reviews.

Other Challenges of Relying on Another Broker-Dealer’s Reviews

We see a variety of other challenges for the introducing broker-dealer hoping to rely on its clearing firm’s reviews:

  1. Determining Whether Reliance Is Reasonable. A broker-dealer should exercise great care when relying on another party to perform a regulatory obligation. This holds true for the introducing broker-dealer that relies on its clearing firm to perform various functions. An introducing broker-dealer would be wise to verify initially and on an ongoing basis that its reliance on its clearing firm’s best-execution reviews is reasonable. Of course, this could be challenging for the introducing broker-dealer that lacks personnel with sufficient knowledge about fixed-income best execution. Ideally, the person who ultimately determines that reliance is reasonable should be sufficiently knowledgeable to make such a determination. Those who currently lack this knowledge can begin the process of acquiring it by reading Implementation Guidance on MSRB Rule G-18, on Best Execution and other information about fixed-income best execution available on the internet.
    2. Interpreting the Results. As a condition of relying on the clearing firm’s reviews, an introducing broker-dealer must periodically review how the clearing firm’s reviews are conducted and the results of the reviews. As with the initial and ongoing determination that reliance is reasonable, some introducing broker-dealers might not have knowledgeable personnel to properly evaluate the clearing firm’s reviews. A clearing firm may fully disclose the results of its reviews, but these results will be of little value to the introducing broker-dealer that cannot interpret them. Best-execution reports and data can be rather complex and difficult to interpret. The introducing broker-dealer that chooses to rely on its clearing firm should make sure its personnel have the requisite skill set to interpret the results.
    3. Documenting the Reviews. Whenever a periodic review is mandated by a rule or regulation, it is prudent to document the completion of each review, even in the absence of any explicit requirement to do so. Presumably, regulators will want to verify that the introducing broker-dealer has a process for gathering and periodically reviewing the results and rationale of its clearing firm’s reviews. In our opinion, an introducing broker-dealer should formally assign the responsibility for performing these periodic reviews to a municipal securities principal or to a best execution committee comprising a municipal securities principal and other qualified individuals. We recommend thoroughly documenting not only the periodic reviews but also the investigation of any red flags (for example, a decline in execution quality).
    4. Identifying and Managing Risks. Broker-dealers have a legal and regulatory obligation to seek the most favorable execution of their customers’ orders. A broker-dealer cannot formally discharge this obligation merely by relying on its clearing firm to seek best execution. Accordingly, an introducing broker-dealer should consider identifying and managing relevant risks (for example, the risk that the clearing firm repeatedly fails to seek best execution on customer orders). Certain measures, such as independently evaluating the execution quality of certain transactions, could help to mitigate risk.
    5. Monitoring Changes in Municipal Securities Business. To rely on its clearing firm’s reviews, an introducing broker-dealer must route its customer’s municipal securities transactions to the clearing firm for handling as agent or riskless principal for the customer. Consequently, an introducing broker-dealer should monitor its municipal securities business for events that would render it unable to continue to rely exclusively on its clearing firm’s reviews (for example, routing customer orders to other executing broker-dealers).

Concluding Thoughts

In an industry of ever-increasing regulation, an introducing broker-dealer may be attracted to the opportunity to minimize its compliance burden by relying on its clearing firm’s best-execution reviews. The introducing broker-dealer should not, however, blindly trust that its clearing firm is achieving best execution; instead, it should diligently monitor the clearing firm’s performance and periodically evaluate the results of the clearing firm’s best-execution reviews.