Best Execution & Trade Quality – An Overlooked Procedure

By Cory Roberson, Principal at FIN Compliance and FIN Lancer

July 11, 2018.  The SEC Office of Compliance Inspections and Examinations’ (“OCIE”) issued a risk alert “Compliance Issues Related to Best Execution by Investment Advisers” that identified discrepancies in client trade quality reviews in its examination of more than 1500 investment advisory firms. 

The SEC Investment Advisors Act, also detailed in this memorandum, defines that an advisor has a fiduciary responsibility to: “(1) select broker-dealers and execute client trades and (2) to seek to obtain “best execution” of client transactions, taking into consideration the circumstances of the particular transactions.”

Amongst the issues, OCIE staff noted that many advisers were not performing periodic internal reviews of best execution (“transactional quality”) for its broker-dealers used to execute client transactions.  Moreover, we’ve noticed similar occurrences for some advisors in our network.

Inside the memorandum, the OCIE outlined seven discrepancies that included:

1. Failure to conduct best execution reviews.  Staff noted that advisors either did not perform a review and/or couldn’t produce the documentation to prove that such a check was ever performed.   

What to do?

Periodically review transactional quality brokerage reports (Rule 605/606).

2. Failure to assess metrics/factors in its best execution review.  The OCIE cited advisors with a lack of: (1) Qualitative reviews of a broker’s execution capability, financial responsibility, and its responsiveness to the advisor, and (2) the firms did not solicit input from its trading team (e.g. traders and portfolio managers).

What to do?

Review metrics in transactional reports and engage trading team for input (e.g. investment committee meetings).

3. Failure to compare results with other broker-dealers.  Staff noted that advisors did not compare quality and costs of other brokers in its reviews.  Specifically, issues included an inspection of reviews: (1) not made on an initial or quarterly basis, (2) assessed on favorable brokerage policies/prices for advisor instead of the clients, and (3) that failed to include any comparison to other brokers.

What to do?

Check trading costs/quality with other brokers

4.  Failure to fully disclosure best execution practices.  The OCIE expressed that many advisors did not provide a full disclosure of its practices.  For example, a disclosure is appropriate when an advisor executes a client trade in the same security after a prior trade was executed.

What to do?

Add accurate trading disclosures on the ADV and Compliance manual. 

5.  Lack of Soft Dollar Disclosures.  The OCIE noted the following deficiencies: (1) advisors did not disclose the use of soft dollar arrangements, (2) firms failed to disclose that some clients may bear more costs than others, and (3) advisors did not provide a full disclosure for products/services acquired with soft dollars.

What to do?

Add disclosures in ADV 2A and procedures manuals.

6.  Mixed use allocation.  Examiners noted a: (1) failure to account for costs associated with bundled products/services and/or (2) no documentation used to justify the use of certain broker-dealers when executing trades for a client. 

What to do?

Check best execution quality for bundled/mixed use arrangements.

7.  Inadequate policies/procedures.  The OCIE staff noted may issues including: (1) a lack of best execution procedures, (2) insufficient internal controls for monitoring transactional quality, (3) failure of advisors to adhere to existing procedures, and/or (4) no soft dollar procedures.

What to do?

Review Procedures

Best Practices for Compliance

Below is a summary of tips to observe transactional quality reviews (“best execution”) including:

Create a review system to conduct best execution checks with trading team (e.g. investment committee meeting).

Retrieve Best Execution reports (Rule 605/606) through each broker-dealer used.

Document and compare results with other broker-dealers.

Document transactional quality in review documents.

Review and document soft dollar arrangements (if any).

Document procedures in your compliance manual. 

Applies to: SEC and State Registrants (Note: Some examiners may place more emphasis on your firm’s Best Execution procedures based upon the advisory business model.) 

Want a further breakdown of best execution and/or policy procedure reviews?

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Email: cory@riareview.com,
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Compliance and Business Management

FIN Compliance (FINCompliance.io) is a consortium of compliance services including: RIA Consults-Roberson Consults Group, a compliance consulting firm, RIA Review, a compliance-management software tool (SaaS), B-D Review, a RIA/Broker-Dealer compliance management software tool, and FINLancer is a business management portal featuring:  E-signature tools; Invoicing integration, Vendor Directory, continuity directory*, business client document portal, and more (available by Q3 2019).  Access all services on one site: FINCompliance.io.

Impact

FIN Missions (FINmissions.com) provides business support group sessions for other entrepreneurs.  In addition, Cory has volunteered for more than fifteen youth programs in locations such as like S. Korea, China, S. Africa, Thailand, and India.