Best Execution: Compliance for Investment Advisers

Under the Investment Advisors Act of 1940 (the “Advisers Act”), Investment Advisers assume a fiduciary responsibility requiring them to seek and obtain the “best execution” for client transactions when trading in client accounts. The United States Securities and Exchange Commission (“SEC”) has outlined this responsibility as “an adviser must execute securities transactions for clients in such a manner that the client’s total costs or proceeds in each transaction are the most favorable under the circumstances.” Also, the SEC has indicated Investment Advisers need to periodically “evaluate the execution quality of the broker-dealer executing their clients’ transactions.”

Best Execution Deficiencies

In the July 2018 OCIE Risk Alert, the SEC highlighted that “the most determinative factor [in an advisor’s best execution analysis] is not the lowest possible commission cost but whether the transaction represents the best qualitative execution for the managed account.” The following common deficiencies were observed during the examinations of firms and emphasized in the Risk Alert:

  • Failing to perform best execution reviews;
  • Not considering materially relevant factors during best execution reviews;
  • Not seeking comparisons from other broker-dealers;
  • Failing to disclose soft dollar arrangements;
  • Not properly administering mixed-use allocations;
  • Not following best execution policies and procedures; and
  • Inadequate policies and procedures relating to best execution.

Soft Dollars

Under Section 28(e) of the Securities Exchange Act of 1934, an Investment Adviser must meet certain requirements to be compliant with soft dollar arrangements. As outlined by the SEC, an Adviser “may pay more than the lowest commission rate, provided that certain specified conditions are met.” Advisers must “make a reasonable allocation of the costs of products and services received with client commissions, according to its use and maintain adequate books and records concerning the allocation.” Additionally, “Advisers must disclose the usage of soft dollars and provide detailed disclosures when the products or services they receive do not qualify for Section 28 (e)’s safe harbor.”

Best Practices for Best Execution

At a minimum, Investment Advisers should set up quarterly, semi-annual, or annual meetings to internally review the execution of client trading. Depending on the type and amount of trading activity at the firm, it may be more appropriate to review more frequently. Also, comparing the firm’s current broker-dealer relationships to a brokerage firm that the firm does not use can provide some additional information on services, costs, and trading practices. Investment Advisers should also make a point to review the qualitative factors of their executing broker-dealers such as financial responsibility, responsiveness to the adviser and order handling, among others. It is important to review and update the policies and procedures for Best Execution to ensure they reflect the firm’s actual practices. Investment Advisers should also review and update all disclosures, such as soft dollars and trading practices, as needed.

Engaging as many members of the trading and portfolio management team as possible enhances the review process regarding trading practices and assists in exposing any potential issues or areas for improvement. Collecting the published trade execution data for each of the current broker-dealers provides additional metrics for review and analysis at these Best Execution meetings.

For more information on the Risk Alert, you can read the full OCIE Risk Alert: Compliance Issues Related to Best Execution by Investment Advisers.

Click to browse our posts on important topics relating to Registered Investment Advisors or the Investment Advisers Act of 1940.

Short URL: http://bit.ly/2pc8cnf