Fiduciary Duty: Best Execution Obligations

As indicated in last month’s column (see “Fiduciary Duty: Best Practices for Fulfilling Suitability Obligations,” Investment Advisor, June 2012), the United States Supreme Court, in 1963, held in SEC v. Capital Gains Research Bureau Inc. that the Investment Advisers Act of 1940 imposes a fiduciary duty on advisors by operation of law. In order to fulfill this duty, an advisor is required to always act in his clients’ best interests and to make full and fair disclosure of all material facts, especially when the advisor’s interests may conflict with those of his clients. In this column, we will address an advisor’s fiduciary duty relative to “best execution” issues.

As fiduciaries, advisors must seek the best available execution for each client’s securities trade. This requires investment advisors to have their clients’ orders executed at prices that are as favorable as possible under prevailing market conditions. An advisory firm should seek to meet its duty of best execution by selecting and recommending broker-dealers that can provide the best qualitative execution, taking into consideration various factors. Such factors include, but are not limited to, the value of research provided (if any), the capability of the firm to execute trades efficiently, quality of price execution, the competitiveness of commission rates and transaction fees, and the overall level of customer service. Thus, while the firm should give significant weight to the competitiveness of the available commission and transaction rates, it may not necessarily select the BD that offers the lowest possible rates. Additionally, even where the firm uses its best efforts to seek the lowest possible commission rate, it may not necessarily obtain the lowest rate for client account transactions. In the event that the recommended BD’s commissions and transactions fees are meaningfully higher than similar BDs, the advisor has the fiduciary duty to clearly disclose that to the client.