Broker-Dealer Exemptive Relief May Affect Advisers’ Allocation Practices

Ethan CoreyLegal InsightsLeave a Comment

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On August 28, 2019, the staff of the Division of Trading and Markets (T&M) of the Securities and Exchange Commission (SEC) issued an exemption letter to Citigroup Global Markets Inc. (CGMI) to enable CGMI to deliver to institutional customers a single confirmation reflecting aggregated execution information for one or more same-side orders executed in each security during that trading day.1 The exemption letter to CGMI (CGMI Exemption) builds upon no-action relief previously issued by T&M that enabled broker-dealers to deliver to institutional customers a single confirmation reflecting aggregated execution information for a single order that is executed in a series of partial executions during the course of a trading day.  As explained further below, investment advisers who wish to authorize CGMI to issue single end-of-day confirmations pursuant to the CGMI Exemption should first review their allocation policies and procedures to ensure that no compliance concerns are triggered.

Current Confirmation Practice

Rule 10b-10 under the Securities Exchange Act of 1934 (Confirmation Rule) requires broker-dealers to disclose specified information in writing to customers at or before completion of a transaction.  Data required by the Confirmation Rule to be disclosed for each customer order include:

  • the date, time, identity, price, and number of shares involved;
  • its capacity (agent or principal) and its compensation (for agency trades, compensation includes its commission and whether it receives payment for order flow; and for principal trades, mark-up disclosure may be required);
  • the source and amount of any third-party remuneration it has received or will receive; 
  • other information, both general (such as, if the broker-dealer is not a SIPC member) and transaction-specific (such as the yield, in most transactions involving debt securities).

However, U.S. institutional trading has long been characterized by broker-dealers: (i) breaking up single orders and executing at multiple prices; (ii) sometimes in multiple capacities (e.g., principal, agent); and/or (iii) in multiple markets.  As a measure to, among other things, accommodate operational efficiencies for broker-dealers and their institutional customers (including registered investment advisers), the T&M staff has provided various forms of relief to broker-dealers to enable them to give or send average price and/or multiple capacity confirmations to confirm single customer orders, effected in multiple executions, in order to achieve best execution for their customers.3 

CGMI Exemptive Request

CGMI stated that it finds that its institutional customers increasingly submit multiple orders electronically rather than a single large order telephonically or through other means.  CGMI represented that in some instances, orders may overlap, resulting in orders being entered before CGMI has completed executing an earlier submitted order.  CGMI, stated that consistent with its best execution obligations, it executes these multiple orders in a variety of ways, including by internalizing, routing to other broker-dealers and trading centers, or effecting riskless principal transactions.  Consequently, CGMI might act as either agent, principal, or both.  CGMI stated that most orders are completed through multiple executions of portions of the original order and at multiple prices.  CGMI stated that its institutional customers prefer to receive single end-of-day confirmations in order to facilitate their ability to allocate aggregated executions pro rata across all of the institutions’ client accounts participating in the orders.

The T&M staff granted CGMI an exemption from elements of the Confirmation Rule so that it is permitted to provide to institutional customers4 a single confirmation reflecting aggregated execution information for one or more same-side orders executed in each security during that trading day, upon the request of the institutional customer.5  In granting the exemption, the T&M staff noted that CGMI’s end-of-day confirmations would include the following items:

  • the date and a notice that execution times are available upon request, consistent with Rule 10b-10(a)(1); 
  • whether the confirmation applied to purchase or sale orders; 
  • a weighted average price, which would be calculated by averaging the execution prices of each individual execution that filled the customer’s orders and weighting that price by the size of the execution; 
  • the capacity or capacities in which CGMI acted in executing the customer’s orders;
  • where required, the total remuneration received;
  • all other information required by Rule 10b-10, as applicable; and
  • notification that, at the customer’s request, CGMI would provide the information required by Rule 10b-10 for each individual transaction, including the actual price and capacity in which CGMI acted. 

It is important to note that currently, the exemption applies only to CGMI.  Other broker-dealers seeking similar relief would need to apply to the T&M staff for their own exemptive relief or for no-action relief.

Should Investment Advisers Begin to Ask for Single End-of-Day Confirms from CGMI?

Whether investment advisers should begin to ask for single end-of-day confirmations from CGMI confirmation reflecting aggregated execution information for multiple same-side orders executed in a security (Multi-Order Confirmation) is likely to depend upon:  (i) whether the multiple same-side orders represent orders on behalf of the same underlying accounts or whether different orders may represent orders on behalf of different underlying accounts; and (ii) the circumstances, if any, under which an adviser’s allocation policies and procedures would allow it to aggregate executions of orders representing one set of accounts with orders representing different sets of accounts.

Accordingly, before an investment adviser begins to ask for a single confirmation reflecting aggregated execution information for multiple same-side orders executed in a security (Multi-Order Confirmation), the investment adviser should review its allocation policies and procedures to ensure that a Multi-Order Confirmation does not create any compliance challenges that would, for example, necessitate requesting individual transaction confirmations.

The unstated assumption behind the CGMI request is that multiple orders submitted electronically by investment advisers to broker-dealers are always the functional equivalent of the single aggregated order submitted by investment advisers to broker-dealers before advisers began to split up an order and transmit its constituent pieces at different times – in particular, the underlying accounts would always be the same.  However, many advisers’ allocation policies and procedures contemplate scenarios in which orders for the same security on behalf of different underlying accounts are transmitted to broker-dealers for execution at different times during the course of a single day.

In these instances, the investment adviser’s allocation policies and procedures may not call for the orders attributable to all the underlying accounts to be aggregated with one another.  And sometimes for good reason – if, for example, one portfolio manager submits a buy order for her accounts at the market open, and the stock later rises, another portfolio manager that submits a buy order for his accounts after the stock rises arguably should not be able to capture a portion of the gain attributable to executions that occurred before he placed his order.

However, there may also be reasons why an investment adviser would want to include an account that was not included in the original aggregated order in a single end-of-day aggregation.  For example, the investment adviser may be waiting to learn if a client-imposed investment restriction would preclude the purchase of the particular security for the client’s account because it is unclear whether the restriction applies.  If it is determined that the restriction would not prohibit the purchase of that security, then the adviser may want to include that client’s account in a single end-of-day aggregation.  But if an adviser’s allocation policies and procedures do not permit an account to participate in an execution if no part of the order was attributable to the account, then regardless of the merits of the case for inclusion, the policies and procedures would prohibit that result. 

In either instance, if an adviser requests a Multi-Order Confirmation, it would not be able to determine how to allocate the executions to the various accounts.  It would then need to request confirmations for each constituent transaction in order to properly allocate the executions to each participating account.

Conclusion

The CGMI letter is likely to be helpful to advisers in instances where: (1) all buy (or sell) orders in a security are attributable to a single set of accounts; or (2) the possibility that new accounts may be added to the order has been contemplated before the fact.  It is less likely to be helpful to advisers in instances where different portfolio managers are operating independently of one another.  And regardless of the scenario, investment advisers should review their allocation policies and procedures to ensure that they are consistent with order routing practices that give rise to Multi-Order Confirmations.  Lastly, broker-dealers other than CGMI who wish to provide institutional customer with Multi-Order Confirmations will need to apply for their own exemptions.  

1Exemption letters issued by T&M apply only to the party requesting the exemption.  No-action letters issued by T&M apply more broadly to all similarly situated parties.
2 Guide to Broker-Dealer Registration, Division of Trading and Markets, United States Securities and Exchange Commission (https://www.sec.gov/reportspubs/investor-publications/divisionsmarketregbdguidehtm.html) (visited Sept. 6, 2019). (citations omitted).
3 New York Stock Exchange, Inc. (SEC Staff No-Action Letter) (pub. avail. Mar. 3, 2005); The Nasdaq Stock Market, Inc. (SEC Staff No-Action Letter) (pub. avail. May 6, 1997); Goldman Sachs & Co. (SEC Staff No-Action Letter) (pub. avail. Apr. 15, 1996).
4 For purposes of the CGMI Exemption, “institutional customers” are customers that meet the definition of “institutional account” in Financial Industry Regulatory Authority (FINRA) Rule 4512(c).
5 Citigroup Global Markets Inc. (SEC Staff Exemption Letter) (pub. avail. Aug. 28, 2019).

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