Gaming the effective spread (transaction costs)

Hi Brave Ones,

Need your help once again.

  1. Just can’t understand how the effective spread can be gamed? How can the broker end up executing buy orders for the client at quoted bid price?

  2. What do they also mean by waiting for others traders to come to them (“seeking liquidity”)?

A broker who has flexibility on how aggressively to fill an order can try to game the effective spread measure by waiting for the trade to come to him—that is, by offering liquidity. The broker with a buy order can wait until an order to sell hits his bid; with a sell order, he can wait until an order to buy hits his ask. By executing buys at the bid and sells at the ask, the broker will always show negative estimated transaction costs if performance is measured by the effective spread. However, the delay costs of this approach to the client may be high.

(Level III 2012 Volume 6 Portfolio: Execution, Evaluation and Attribution, and Global Investment Performance Standards, 5th Edition. Pearson Learning Solutions p. 25).

many thanks