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Difficulty: MediumProhibited Market Manipulation and Fraudulent Practices

A broker-dealer receives a retail customer's order to purchase shares of an over-the-counter (OTC) equity security. Rather than executing the trade directly with the market maker offering the best available price, the broker-dealer routes the order through an unaffiliated third-party broker-dealer, who purchases the shares from the market maker and forwards them. Both broker-dealers add a markup to the transaction. Which prohibited practice has the customer's broker-dealer committed?

  1. Interpositioning, by inserting an unnecessary intermediary between the customer and the best market price.Answer
  2. B
    Wash trading, by executing transactions that result in no actual change of beneficial ownership.
  3. C
    Principal trading, by filling the customer order out of the broker-dealer's existing inventory.
  4. D
    SRO jurisdiction violation, by conducting transactions outside of FINRA trade-reporting system oversight.

Answer

Interpositioning, by inserting an unnecessary intermediary between the customer and the best market price.
The correct answer identifies interpositioning, which is the prohibited practice of introducing a third party between a customer and the best available market price. FINRA rules mandate that broker-dealers provide best execution; routing orders through another broker-dealer without demonstrating a benefit to the customer causes unnecessary markups and directly violates regulatory standards.

Step-by-Step Solution

1
Analyze the broker-dealer's order execution path.
The broker-dealer routed a customer order through a third-party intermediary broker-dealer instead of trading directly with the market maker displaying the best price.
Broker-dealers are required to exercise reasonable diligence to obtain the best execution price for their customers.
2
Evaluate the financial impact on the customer.
Both the third-party intermediary and the customer's broker-dealer charged markups, increasing the final cost to the retail customer.
Inserting a third party that adds no value and increases execution costs violates customer protection rules.
3
Identify the regulatory violation.
This conduct constitutes prohibited interpositioning under FINRA Rule 5310.
Interpositioning is explicitly prohibited unless the firm can demonstrate that using an intermediary resulted in a better execution for the customer.

Key Concept

Interpositioning and Best Execution Obligations
Estimated Time:1m 0s
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Topics

Prohibited Market Manipulation and Fraudulent Practices