Internalization and Execution Quality: Ranking US Brokerage Firms

November 23, 2004

Abstract

According to

Octavio Marenzi, Celent CEO and co-author of the report, "The SEC’s recent efforts to establish best price as the top priority for brokers handling investor stock orders is a step in the right direction and is desperately needed. Customer orders are frequently executed at prices worse than those available on the public markets. Indeed, in the second quarter of this year, just under one-fifth of all orders were executed at prices worse than the best prices visible on the public markets," adds Marenzi.

This 42-page report contains 23 figures and seven tables. A

is available online.

Boston, MA, USA November 23, 2004

In a new report, Celent examines the impact of internalization on execution quality and ranks leading US brokerage firms in terms of the quality of the equity trade executions they achieve for their customers.

The increasing tendency for brokerage firms to internalize trades has raised more than a few eyebrows. This practice, whereby a brokerage firm trades against its own clients’ orders and denies these orders the possibility of interacting with the public markets, appears to be laden with conflicts of interest. However, Celent’s analyses show that major US brokerage firms have appeared to managed these conflicts well. examines the extent to which orders are internalized and what impact internalization has on execution quality.

The report examines in detail the execution quality of 16 leading US brokerage firms: AG Edwards, Bear Stearns, Banc of America, Charles Schwab, Citigroup, CSFB, Deutsche Bank, Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley, NFS (Fidelity), Prudential, TD Waterhouse, UBS, and Wachovia.

Execution quality was measured using a number of criteria, including speed of order execution and prices achieved for clients. Data used in the report come from the second quarter of this year. The table below shows the top three firms overall as well as those ranked tops for prices and execution speed.

Rankings of Brokers' Execution Quality
Rank Prices Speed Overall
1 UBS Morgan Stanley Citigroup
2 Bear Stearns NFS (Fidelity) NFS (Fidelity)
3 Citigroup Charles Schwab Goldman Sachs
Source: Celent Communications

of Celent Communications' Retail Securities & Investments and Institutional Securities & Investments research services can download the report electronically by clicking on the icon to the left.  Non-members should contact info@celent.com for more information.

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned subsidiary of Marsh & McLennan Companies [NYSE: MMC].

Media Contacts

North America
Michele Pace
mpace@celent.com
Tel: +1 212 345 1366

Europe (London)
Chris Williams
cwilliams@celent.com
Tel: +44 (0)782 448 3336

Asia (Tokyo)
Yumi Nagaoka
ynagaoka@celent.com
Tel.: +81 3 3500 3023

Table of Contents

 

Boston, MA, USA November 23, 2004

Internalization and Execution Quality

Return to report Abstract

 

EXECUTIVE SUMMARY 3
INTRODUCTION 4
  Background 4
  Definition of Internalization 4
  Typical Order Flow for US Equities 5
  Execution Quality 7
APPROACH TO INTERNALIZING ORDER FLOW 8
  Internal Market-Making Operations 8
  Competing Specialist Systems on Regional Exchanges 8
  Ownership of Specialists on NYSE 9
  Internalization Through Clearing Firm 10
PAYMENT FOR ORDER FLOW 11
STATISTICS ON INTERNALIZATION 13
EXECUTION QUALITY 18
  Background 18
  Data Used in Report 18
  Execution Price 18
  Spread 25
  Speed 29
IMPACT OF INTERNALIZATION ON EXECUTION QUALITY 33
OVERALL RANKING OF EXECUTION QUALITY 35
CONCLUSION 40
OBJECTIVITY & METHODOLOGY 41

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