## Facts

- E.F. Hutton & Co. was a registered broker-dealer and a NASDAQ market maker in Genex Corporation stock.
- A customer, William Manning, placed a sell limit order with Hutton for Genex at a specified minimum price.
- While holding the unexecuted customer limit order, Hutton executed proprietary trades in Genex at prices higher than the customer’s limit price.
- The NASDAQ “inside bid” in the public quotation system did not reach the customer’s limit price during the relevant period.
- Manning’s limit order was not executed; Genex later declined in price, and Manning lost the opportunity to sell at the higher prices reflected by Hutton’s proprietary sales.
- The NASD found Hutton’s conduct violated its duties to the customer and NASD rules requiring fair dealing and just and equitable principles of trade, and it imposed sanctions.
- Hutton sought SEC review, contending it had no obligation to prioritize or execute the customer’s order given the inside bid never reached the limit price and the customer understood Hutton’s market-maker role.

## Issues

1. Whether a broker-dealer that accepts a customer limit order, while also acting as a market maker and proprietary trader in the same security, must give the customer order priority over the firm’s proprietary trades.
2. Whether proprietary trading at prices better than an unexecuted customer limit order violates NASD rules and fiduciary/agency duties when the publicly quoted inside bid does not reach the limit price.
3. Whether the customer’s sophistication and knowledge of the firm’s market-maker status reduces or eliminates the firm’s duty to avoid trading ahead of the customer order.

## Decision

- The SEC sustained the NASD’s determination that Hutton violated applicable NASD conduct rules by failing to give the customer’s limit order priority over Hutton’s proprietary trading.
- The SEC rejected the argument that the absence of an inside bid at the limit price excused Hutton’s conduct where Hutton itself executed trades at better prices.
- The SEC concluded that customer sophistication and awareness of Hutton’s dual role did not waive or negate the firm’s duties arising from accepting the customer order.
- The SEC sustained the imposition of NASD disciplinary sanctions.

## Legal Principles

- When a broker-dealer accepts a customer order, it acts as the customer’s agent and owes duties of loyalty and fair dealing in handling that order.
- A firm holding a customer limit order may not place its proprietary interest ahead of the customer’s interest by executing proprietary trades at more favorable prices while leaving the customer order unexecuted, absent clear consent and appropriate handling.
- Quotation-system mechanics (including whether the inside bid reaches the limit price) do not define the full extent of the broker’s obligations when the firm is demonstrably able to trade at better prices.
- A customer’s sophistication or knowledge that the broker is also a market maker does not eliminate the broker’s duty to treat the customer order fairly and avoid using conflicts to the customer’s disadvantage.
- Conduct that amounts to trading ahead of customer limit orders can violate SRO rules requiring high standards of commercial honor and just and equitable principles of trade.

## Conclusion

The SEC affirmed NASD discipline against a broker-dealer/market maker that executed proprietary trades at better prices while holding an unexecuted customer sell limit order, holding that agency-based duties and NASD fair-dealing rules require customer-order priority notwithstanding the customer’s sophistication or the inside-bid level.


In re E.F. Hutton & Co., Exchange Act Release No. 25887, 41 S.E.C. Docket 413 (1988)