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88-85 Securities and Exchange Commission Decision Re: Handling Customers' Limit Orders

SUGGESTED ROUTING*

Senior Management
Internal Audit
Legal & Compliance
Operations
Syndicate
Trading

*These are suggested departments only. Others may be appropriate for your firm.

EXECUTIVE SUMMARY

The Securities and Exchange Commission has affirmed a finding by the NASD Board of Governors that a member firm, by accepting a customer's limit order, had an obligation to give that order priority over its own proprietary position unless it had previously arrived at a different understanding with the customer.

BACKGROUND

The Securities and Exchange Commission has issued a decision In the Matter of the Application of E.F. Hutton & Company, Inc., n/k/a Shearson Lehman Hutton, Inc., (Securities Exchange Act Release No. 25587) in which the Commission affirmed findings by the NASD Board of Governors that Hutton had failed to properly carry out its obligations to its customer in the manner in which the firm handled the customer's limit order.

The facts of the case were that a customer of the firm had placed an open limit order to sell 5,000 shares of an over-the-counter security at a price of 17 1/8. The firm accepted the order at a time when it was a registered market maker in the security with quotes in the NASDAQ System of 17 bid, 17 1/2 asked. While holding the customer's order, the firm sold shares from its inventory at prices higher than the 17 1/8 price sought by the customer.

The Commission affirmed the NASD's conclusion that, by accepting the customer's limit order, the firm had an obligation to give that order priority over its own proprietary position unless it had previously arrived at a different understanding with the customer. Since no such understanding had been reached in this case, the NASD and the Commission concluded that the firm did not fulfill its obligations to the customer and that such activity constituted a violation of Article III, Section 1 of the NASD Rules of Fair Practice. The Commission found "[i]t is hornbook law that, absent disclosure and a contrary agreement, a fiduciary cannot compete with his beneficiary with respect to the subject matter of their relationship."1 The Commission concluded that the practice at issue affected the fundamentals of the broker-dealer customer relationship in that the firm was, in effect, competing with the customer with respect to the subject matter for their relationship — the execution of the order.

This matter is currently on appeal before the United States Court of Appeals for the District of Columbia Circuit.

Questions regarding this notice may be directed to Dennis C. Hensley, Vice President and Deputy General Counsel, at (202) 728-8245, or T. Grant Callery, Associate General Counsel, at (202) 728-8285


1 Securities and Exchange Act Release 25587 (July 6,1988) p. 6. Footnote omitted.



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