Compliance Alert: OCIE Issues Best Execution Risk Alert

Compliance Alert: OCIE Issues Best Execution Risk Alert

Among a variety of other requirements, investment advisers have a fiduciary duty to seek the best available execution for each client’s trades at the most favorable prices possible under current market conditions.

Meeting Best Execution Obligations

Advisers meet their fiduciary obligations of seeking best execution by working with broker-dealers that they believe can conduct transactions and provide best execution for investors.   This determination is based on a number of factors, which usually include but are not limited to the following:

  • The available research findings
  • Execution and settlement capabilities
  • Capital strength and stability
  • Competitive transaction costs
  • The broker-dealer’s trading efficiency and recent order flow
  • Confidentiality
  • Quality of customer service
  • Knowledge of the other side of the trade
  • Research

 

As part of their best execution review, an advisory firm should consider its historical experience with a broker-dealer, conduct independent surveys, review execution data and reports from the  broker-dealers, and consider trade execution quality and routing data from other broker-dealers. (Read more about the importance of best execution here.)

Failures of Best Execution Policies — OCIE Issues Alert

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) recently issued a Risk Alert that includes a list of the most common compliance deficiencies found during exams concerning failures pertaining to  best execution obligations of SEC-registered investment advisers.

Those issues listed by OCIE in the Risk Alert are the following:

  • Not performing best execution reviews
  • Not considering materially relevant factors during best execution reviews
  • Not seeking comparisons from other broker-dealers
  • Not fully disclosing best execution practices
  • Not disclosing soft dollar arrangement
  • Not properly administering mixed use allocations
  • Inadequate policies and procedures relating to best execution
  • Not following best execution policies and procedures

Quoting the Risk Alert directly, “the determinative factor [in an adviser’s best execution analysis] is not the lowest possible commission cost but whether the transaction represents the best qualitative execution for the managed account. Advisers should therefore periodically and systematically evaluate the execution quality of broker-dealers executing their clients’ transactions.” 

(You can read the full Risk Alert document here.)

All of these concerns outlined by OCIE affect an advisory  firm’s ability to meet its fiduciary obligation of seeking best execution.

Best Execution Reviews — Steps Your Firm Should Take

The first step in establishing best execution reviews is to develop an effective process for internal testing that evaluates quality of execution.

The next step is to   adopt a comprehensive best execution policy that is focuses on steps taken prior to trade placement, during trade execution, and post-execution.

 In addition to having a robust broker-dealer selection process, advisers should have effective surveillance tools and testing procedures that measure trade execution and transactions costs should be put into place in order to determine the trade quality of a broker-dealer over time. .

Any findings that come from surveillance and testing should be documented so that all decisions and actions can be supported in case of inquiry by the SEC or other regulatory bodies.

Achieving comprehensive policies and internal testing procedures that monitor whether a firm is seeking and achieving  best execution can be somewhat overwhelming and a bit of an administrative burden

Core Compliance & Legal Services, Inc., consultants have worked in the investment advisory industry for many years and understand the complexities and intricacies of advisory business operations at all levels. For assistance with best execution determinations, risk assessments, mock examinations, soft dollar considerations, and trade allocation procedures, find more information here.