Kelley A. Howes and Susan I. Gault-Brown
Broker-Dealer Compliance + Regulation and Investment Management
On July 11, 2018, the SEC’s Office of Compliance Inspections and Examinations (OCIE) published a Risk Alert identifying the most common deficiencies that its staff observed in recent examinations of registered investment advisers’ best execution practices. As with prior OCIE Risk Alerts, investment advisers should carefully examine their compliance policies and procedures in light of the issues identified by OCIE and make improvements where necessary.
An investment adviser that has authority to select the broker-dealers that execute securities transactions for its clients has an obligation to seek “best execution.” That is, transactions should be executed “in such a manner that the client’s total costs or proceeds in each transaction are the most favorable under the circumstances.”
Best execution does not mean, however, “lowest cost.” Indeed, OCIE stated in the Risk Alert that “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 [client’s] account.” In addition, an adviser’s assessment of best execution may be affected by whether or not it receives brokerage or research services under soft-dollar arrangements entered into under the safe harbor in Section 28(e) of the Securities Exchange Act of 1934, which enables an adviser to pay more than the lowest commission rate available for a particular trade without breaching its fiduciary obligations, provided that the conditions of Section 28(e) are met.
Common Compliance Issues
In the Risk Alert, OCIE reminds investment advisers that they have an obligation to perform periodic and systematic reviews of the execution quality obtained from broker-dealers executing their clients’ transactions. Investment advisers also have disclosure obligations related to their best execution policies and their use of soft dollars. According to OCIE, the SEC staff has identified several common deficiencies related to these obligations:
As with prior Risk Alerts, OCIE’s decision to broadly identify the types of deficiencies it is seeing with respect to best execution gives advisers an opportunity to review their existing policies and procedures, and to ensure that they have appropriately addressed the identified concerns in the context of their particular business. To the extent an investment adviser determines that its disclosures, policies, or procedures are lacking, it should proactively amend such documents (or otherwise change its practices) to address the deficiency. Moreover, when conducting its periodic reviews of best execution and the appropriate level of comparisons among broker-dealers, an investment adviser should ensure that it evaluates execution-related factors other than just the cost of execution, and should conduct such reviews in the context of its particular business.
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