What's Inside the SEC’s Best Execution Risk Alert 

Many advisors mistakenly presume that maintaining their clients’ assets with a major RIA custodian adequately addresses any best execution concerns.

The confusion surrounding this topic is not helped by the fact that “best execution” and associated obligations are not specifically defined under the Investment Adviser Act of 1940 or related securities regulations. Instead, the Securities and Exchange Commission has offered limited specific guidance through various releases and other interpretive material.

For years, I have defined best execution as both a qualitative (the overall service provided by the broker-dealer/custodian) and quantitative (pricing, as to transaction costs and price execution) evaluation.

In July, the SEC’s Office of Compliance Inspections and Examinations published a Risk Alert addressing commonly identified compliance issues cited in advisor examinations. My colleague and compliance attorney Jeff Lang outlined what specific issues the SEC addressed.

The SEC’s primary issue was to remind advisors that, as fiduciaries, they must seek “best execution” of client transactions, which includes consideration of a client’s total costs or proceeds and the quality of broker-dealer services, Jeff said.

As the SEC has stated, “the 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.”

Advisors can take several steps to enhance compliance, according to the Alert. First, advisors must maintain adequate best execution policies and procedures, which are designed to address their current business and trading practices. Effective procedures define which staff members are responsible for conducting best execution reviews, along with the manner and frequency of these reviews.

Moreover, advisors must follow these procedures, which entails both monitoring and documenting BD execution performance. Many advisors have been cited for not maintaining satisfactory policies, having insufficient internal controls and failure to monitor BD execution performance.

As the SEC clarified, a comprehensive BD review also should encompass qualitative factors, including execution capability, financial responsibility and responsiveness.

OCIE also observed that advisors often fail to evaluate their BDs in comparison to the quality or cost of services available from other BDs.