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Regulation and Compliance > Federal Regulation > SEC

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

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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.

That is, advisors utilizing one custodian for all client transactions failed to conduct initial or ongoing due diligence of alternative BDs to verify that their current broker recommendation remains appropriate. Thus, advisors should periodically apply the same evaluative criteria to other available custodians.

Also highlighted was adequate disclosure of best execution practices. That is, advisors must accurately describe their best execution practices in Form ADV. They must then oversee brokerage and custodial services received in a manner consistent with this disclosure.

OCIE referenced that advisors failed to review historic trading activity to affirm that prices received were favorable under prevailing market conditions.

OCIE further noted that firms must fully disclose participation in soft or hard dollar programs regarding allocation of brokerage activity and the receipt of research or other services.

This includes clear disclosure of the products and services received through such arrangements. The SEC remains particularly focused on disclosure of the additional costs that may be passed along to certain clients.

Jeff recommends that depending upon your firm’s size, consider implementing a best execution committee to periodically evaluate your broker-dealer relationships.

Be sure to document how this review is conducted. For example, many firms begin by obtaining and reviewing various best execution quality reports made available by their selected custodian(s).

This may be supplemented by conducting a trade execution quality analysis (or requesting similar information from your executing brokers, where available).

Also, engage your trading and operational staff to help provide an adequate qualitative analysis of the services received from each broker. Most important, be sure to consistently follow and document your process!

Thomas D. Giachetti is chairman of the Securities Practice Group of Stark & Stark. He can be reached at [email protected].


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