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If a "no advice" (order execution only) discount broker is a member of a major stock exchange, does that typically obligate the broker to accept client orders for all stocks, ETFs, etc. listed on the exchange? Or, is a broker completely free to restrict the set of listed securities that its clients can buy and sell?

By completely free, I mean to ask whether a broker can ban trades for a listed issue for whatever reason the broker wants — i.e. at their absolute discretion, and for their own selfish reasons. I know there are times when exchanges and regulators issue cease-trade orders for stocks, but it's not these kinds of "unable to take your order" situations that I'm asking about.

Imagine that you called your broker and tried to place a buy order for an ETF issued by a reputable fund company. The ETF is listed on a major exchange, and your broker is a member of that exchange.

Your discount broker — among the largest around, and part of a huge financial conglomerate — advertises broad market access. The broker's literature describes the diversification and liquidity benefits of ETFs, the convenience of ETF trading during market hours, and ease of access to third-party ETFs. In Canada, your broker is a member of IIROC. Your broker's affilated U.S. operation is a member of FINRA.

And yet your broker says: "Sorry — we don't allow buy orders for that ETF."

When pressed for more information, you learn they simply decided to forbid buy orders for the ETF because it competes with a similar "in-house" fund offering. Yet, the in-house fund isn't an ETF, and is less attractive as an investment. But selling it is good for the bottom line of the broker's financial conglomerate parent, who also owns the issuer of the in-house fund, and stands to gain more from fees & spreads on your investment than a $10 commission for selling you the competitor's ETF.

In this situation, has the broker done anything wrong in restricting access to a competitor's ETF?

Is this merely a broken marketing promise, or might the broker be failing to uphold an obligation in terms of regulation they are subject to, or in terms of some kind of reasonably expected responsibility to their clients?

I'm interested in answers with repect to both the U.S. and Canada, being the two countries whose stock markets I have ready access to and often trade in.

  • Are you asking for broad information about brokers denying trades or are you asking for specific information about your imaginary situation? An edit to the question to clarify would help, either focus on the broad question or narrowly on the specific hypothetical. – Freiheit Apr 30 '18 at 22:08
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    In the US, brokers are obligated to operate in good faith and follow the directives of an investor. "Failure To Execute" can create liability. Brokers can refuse to participate in certain markets (options, futures, crypto, etc.) but it doesn't sound kosher to be refusing to execute an ETF trade, assuming it's not something like shorting an exotic 3X leveraged VIX ETN with margin issues. If you want clarity, contact FINRA (U.S.). – Bob Baerker May 1 '18 at 11:31
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    Vanguard no longer takes orders for leveraged or inverse ETFs, and I'm sure their lawyers investigated quite thoroughly to ensure that was a legal move. – Kevin Jun 27 at 18:24
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    @chris-w-rea can you please list the name of the etf and the Discount broker name – Raj Jun 28 at 15:00
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    @Raj TD Direct Investing (here in Canada) blocks client orders for the Purpose High Interest Savings ETF (symbol PSA) that trades on the Toronto Stock Exchange (TSX). – Chris W. Rea Jun 28 at 17:46
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Discount brokers make their money from commissions and margin interest, so it is generally in their interest to allow trading in securities where possible.

However they have to balance it against risk. The risk can be managed in a number of ways. They may impose higher margin requirements or not offer margin treatment to certain securities at all or they may suspend trading in a particular security altogether. Doing so however may be fraught with problems, such as clients holding positions might need to transfer their accounts to another broker in order to be able to close out their positions. That is an extreme example, but it could come to that.

Brokers are also influential, so instead of prohibiting clients from trading certain securities they could ask the exchange to de-list certain securities (or perhaps more appropriately, accelerate their review of certain securities for de-listing). Once de-listed, it would then become a matter of the broker not having access to the platform where the securities are traded (presumably more palatable for the customer).

However, the opposite can also be problematic. I recall a broker who sold bonds in Enron to customers (presumably to unload their positions) after their bankruptcy was announced. They were fined heavily.

If there is not a specific Exchange or FINRA rule it could be argued that it falls within a catch-all such as "just and equitable principles of trade" (FINRA Rule 2010 - most brokers are FINRA members).

So restricting trading in competitor's ETFs? I think you could make an argument that it is against just and equitable principles of trade.

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(I am neither a lawyer nor financial adviser; this neither legal nor financial advise.)

TL;DR: Refusing to execute an order because of a broker's competing product would seem to be at least against the spirit of both SEC/FINRA regulations. If there are no clauses that specifically prohibit such action, it certainly seems to be against the overarching principle of "play fair" that permeates those regulations.


Excerpting from Section [V.A.1] of the SEC's Guide to Broker-Dealer Registration (and adding some emphasis of my own):

V. CONDUCT REGULATION OF BROKER-DEALERS

A. Antifraud Provisions (Sections 9(a), 10(b), and 15(c)(1) and (2))

The "antifraud" provisions prohibit misstatements or misleading omissions of material facts, and fraudulent or manipulative acts and practices, in connection with the purchase or sale of securities.3

1. Duty of Fair Dealing

Broker-dealers owe their customers a duty of fair dealing. This fundamental duty derives from the Act's antifraud provisions mentioned above. [...] a broker-dealer represents to its customers that it will deal fairly with them, consistent with the standards of the profession. Based on this important representation, the SEC, through interpretive statements and enforcement actions, and the courts, through case law, have set forth over time certain duties for broker-dealers. These include the duties to execute orders promptly, disclose certain material information (i.e., information the customer would consider important as an investor), charge prices reasonably related to the prevailing market, and fully disclose any conflict of interest.

SRO rules also reflect the importance of fair dealing. For example, FINRA members must comply with NASD's Rules of Fair Practice. These rules generally require broker-dealers to observe high standards of commercial honor and just and equitable principles of trade in conducting their business. The exchanges and the MSRB have similar rules.

In general terms, these indicate to me that at all times a broker should act "fair and above board". In particular, if there is a conflict of interest, this must be fully disclosed. In the context of the original question, I would take this to mean that – if they are allowed to refuse to trade some securities at all – then at a minimum any "banned" securities should be clearly listed upfront, before an attempt to trade in them.

(As noted in comments, a broker can refuse to allow trading in certain classes of securities such as options or futures (indeed, in many cases they must refuse to allow someone to trade unless or until they are satisfied that the person is aware of the risks). But refusing to trade specific stocks or ETFs would seem to go against the spirit of the above guidance).

The above guidance says "FINRA members must comply with NASD's Rules of Fair Practice". These rules are many and varied, but Rule 5420 from the FINRA manual includes (emphasis mine):

5240. Anti-Intimidation/Coordination

(a) No member or person associated with a member shall:

[some specifics omitted]

This includes, but is not limited to, any attempt to influence another member or person associated with a member to adjust or maintain a price or quotation, whether displayed on any facility operated by FINRA or otherwise, or refusals to trade or other conduct that retaliates against or discourages the competitive activities of another market maker or market participant.

I believe refusing an order because the broker has their own, competing product, could well be argued as falling foul of the highlighted section.

From the same source, Rule 5310. Best Execution and Interpositioning covers a broker's duty and obligations to execute an order at the best available price (and the required diligence in finding the best price). Some of the supplementary material to that rule would seem applicable to the original question:

.01 Execution of Marketable Customer Orders. A member must make every effort to execute a marketable customer order that it receives fully and promptly.

No mention of "unless the member has a competing product".

.02 Definition of "Market." For the purposes of Rule 5310 and the accompanying Supplementary Material, the term “market” or “markets” is to be construed broadly, and it encompasses a variety of different venues, including, but not limited to, market centers that are trading a particular security. This expansive interpretation is meant to both inform broker-dealers as to the breadth of the scope of venues that must be considered in the furtherance of their best execution obligations and to promote fair competition among broker-dealers, exchange markets, and markets other than exchange markets, as well as any other venue that may emerge, by not mandating that certain trading venues have less relevance than others in the course of determining a firm's best execution obligations.

While the thrust of the rule is about the lengths the broker has to go to in ensuring they get the best price, the highlighted passages indicate that FINRA's expectations of "fair play" are high. Refusing to execute an order because the broker has their own competing fund would not, I suggest, "promote fair competition".

.08 Customer Instructions Regarding Order Handling. If a member receives an unsolicited instruction from a customer to route that customer's order to a particular market for execution, the member is not required to make a best execution determination beyond the customer's specific instruction. Members are, however, still required to process that customer's order promptly and in accordance with the terms of the order.

Again, the main thrust of this supplement is about "best price" (specifically when the member is not obligated to fine one). However, once again the highlighted passage seem to convey FINRA's intention that all such orders must be executed, and, for example, cannot be refused just because the broker has a competing fund.

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