SEC Issues Risk Alert on Best Execution Practices

Investment Management Update

Date: July 24, 2018

The SEC’s Office of Compliance Inspections and Examinations (OCIE) recently published a list of the most common deficiencies concerning adviser compliance with best execution obligations under the Investment Advisers Act of 1940 (Advisers Act). The Advisers Act establishes a federal fiduciary standard that all investment advisers must adhere to with respect to best execution of client transactions. An adviser must take several factors into consideration in satisfying its best execution obligations, including total cost or proceeds and range and quality of a broker-dealer’s services.

Listed below are eight common best execution-related deficiencies OCIE identified in recent adviser examinations.

Failing to perform best execution reviews. OCIE observed advisers who failed to demonstrate that they periodically and systematically evaluate the performance of broker-dealers used to execute client transactions. OCIE recommends that advisers conduct best execution evaluations when selecting broker-dealers and document those evaluations.

Failing to consider materially relevant factors during best execution reviews. OCIE observed advisers who did not consider the full range and quality of a broker-dealer’s services in directing brokerage. Common observations included:

  • Advisers failing to evaluate qualitative factors such as execution capabilities, financial responsibility and responsiveness to the adviser.
  • Advisers failing to consider feedback from its traders and portfolio managers during the adviser’s best execution review.

Failing to seek comparisons from other broker-dealers. OCIE observed advisers who did not seek out or consider the quality and costs of services available from broker-dealers that the adviser is not currently utilizing. Common observations included:

  • Advisers utilizing one broker-dealer for all client transactions without conducting initial or ongoing due diligence of alternative broker-dealers.
  • Advisers utilizing one broker-dealer based only on minimal reviews of either the broker-dealer’s policies and prices or its brief marketing summary.

Failing to fully disclose best execution practices. OCIE observed advisers who did not provide full disclosure of best execution practices. In some instances, advisers failed to disclose that certain types of accounts may trade the same securities at different times, which could impact the execution prices. In other instances, contrary to disclosures, advisers failed to review trades to ensure prices fell within an acceptable range.

Failing to disclose soft dollar arrangements. OCIE observed advisers who did not provide a full and fair disclosure in Form ADV of their soft dollar arrangements. Common observations included:

  • Advisers not disclosing the use of soft dollar arrangements.
  • Advisers not disclosing that some clients may bear more of the cost associated with soft dollar arrangements than others.
  • Advisers not providing adequate or accurate disclosures regarding products or services that are acquired with soft dollar arrangements.

Failing to properly administer mixed use allocations. OCIE observed deficiencies related to mixed use allocations, such as advisers not making reasonable allocations of the costs of  mixed use products or services, or not producing support (documentation or otherwise) for the rationale for its mixed use.

Failing to establish adequate best execution policies and procedures. OCIE observed advisers who had inadequate compliance policies and procedures or internal controls regarding best execution. Common observations included:

  • Advisers did not have any best execution policies.
  • Advisers had insufficient internal controls because they failed to monitor broker-dealer execution performance.
  • Advisers had outdated policies that failed to reflect their current business.

Failing to follow best execution policies and procedures. OCIE observed advisers who did not follow their best execution policies and procedures, including failing to conduct due diligence on competing broker-dealers to test for pricing and execution. OCIE also observed advisers who failed to allocate soft dollar expenses in accordance with their policies and those who did not follow their policies regarding ongoing monitoring of execution price, research and broker-dealer responsiveness.

Takeaway

OCIE’s recent publication is intended to inform investment advisers about the importance of maintaining accurate policies and procedures aimed at best execution and soft dollar arrangements to better protect advisory clients. OCIE recommends that advisers review their best execution and soft dollar allocation practices, policies and procedures and continue to promote improvements in adviser compliance programs.

FOR MORE INFORMATION

For more information, please contact:

Andrew J. Davalla
614.469.3353
Andrew.Davalla@ThompsonHine.com

Michael V. Wible
614.469.3297
Michael.Wible@ThompsonHine.com

Ryan S. Wheeler
513.352.6693
Ryan.Wheeler@ThompsonHine.com

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