Assessing Quantum in Best Execution Claims

COBS 11.2 requires a firm to take all reasonable steps to obtain, when executing orders, the best possible result for its clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature and anything else relevant.

The importance of different criteria can vary depending on the type of investment and would be different for stocks, bonds or options.  For example, the type of investment would dictate whether it is traded on an exchange or over the counter which introduces a timing issue.   A high total volume of trades will impact on price and require a series of trades (usually dictated by an algorithm).  There may be a short term supply and demand problem or a company specific press release or news item.  

Forced sales, margin calls and highly leveraged positions require these issues to be weighed up together.  Especially where positions cannot be unwound in a single day's trading.  The most common causes for complaint relate to the impact of trades on the market, balancing price slippage with frequency of trades, not following an internal policy and calculating the missed opportunity cost of the best alternative option.  In other words, would better prices have been achieved "but for" the poor execution?  

This can be analysed by comparing the average market price achieved with the actual price achieved.  Volume Weighted Average Price (VWAP) is the average cost of the investment during a trading period – calculated by multiplying the number of shares purchased by their share price and dividing by the total number of shares bought.  A financial institution may have their own VWAP.  If the price of a sell trade is higher than the VWAP it is a good trade and the opposite is true if the price is lower than the VWAP.  In a falling market it may have been difficult to outperform this benchmark but in a chaotic or disrupted market following a news event or announcement there is more opportunity to do so.

The collapse of Lehman Brothers caused an uncontrolled cascade of closeouts and automatic termination of derivatives.  However, it can be difficult to estimate whether any losses were caused as a result of poor execution because of a lack of historic market data as to whether quotes could have been traded or were indicative only.  Obtaining this data is important for putting a firm value on any claim and, if the investment is listed on more than one market, may be derived from a secondary exchange or market.

Jonathan Kitchin is a member of the Commercial & Regulatory Disputes team and can be contacted on jonathan.kitchin@michelmores.com or 01392 687635.