Many advisors mistakenly pre- sume 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 iden-
tified compliance issues cited in advisor
examinations. My colleague and compli-
ance 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 consider-
ation of a client’s total costs or proceeds
and the quality of broker-dealer servic-
es, Jeff said. As the SEC has stated, “the
determinative factor [in an advisor’s best
execution analysis] is not the lowest pos-
sible commission cost but whether the
transaction represents the best qualita-
tive execution for the managed account.”
Advisors can take several steps to
enhance compliance, according to the
Alert. First, advisors must maintain ade-
quate best execution policies and proce-
dures, 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 disclo-
sure of best execution practices. That is,
OCIE further noted that firms must
fully disclose participation in soft or
hard dollar programs regarding allo-
cation 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 firstname.lastname@example.org.
THE COMPLIANCE COACH
By Thomas D. Giachetti
Inside the SEC’s Best Execution Risk Alert
Advisors often don’t realize that best execution requirements have many
facets, all of which are worth a careful review.