Tag: Best Execution

Compliance Issues Related to Best Execution

Under the Investment Advisers Act, investment advisers selecting broker-dealers for executing client trades have an obligation to seek to obtain “best execution” of those transactions. The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a new risk alert highlighting many of the most common deficiencies that the OCIE staff has cited in recent examinations of advisers’ compliance with their best execution obligations.

Best execution requires taking the circumstances of the particular transaction into consideration. A best execution analysis is whether the transaction represents the best qualitative execution for the client, rather than whether the transaction has the lowest possible commission cost. In directing brokerage, an adviser should consider the full range and quality of a broker-dealer’s services including:

  • the value of research provided,
  • execution capability,
  • commission rate,
  • financial responsibility, and
  • responsiveness to the adviser.

It’s not just the cost. But be sure, that OCIE will look at the cost first, and it’s likely the adviser will have to justify using a higher cost.

The OCIE alert highlights the top eight issues their staff encounters during exams:

  1. Failure to perform best execution reviews
  2. Failure to consider materially relevant factors during best execution reviews
  3. Failure to seek comparisons from other broker-dealers
  4. Failure to fully disclose best execution practices
  5. Failure to disclose soft dollar arrangements
  6. Failure to properly administer mixed use allocations
  7. Failure to implement best execution policies and procedures
  8. Failure to follow best execution policies and procedures

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Best Execution Failure

Exécution_de_Marie_Antoinette_le_16_octobre_1793

Best execution refers to the obligation of an investment adviser to ensure that the prices its orders receive reflect the optimal mix of price improvement, speed and likelihood of execution. The concern is whether the investment adviser is getting some other compensation that influences the decision to use one broker over another. This concern should be heightened when there is an affiliate involved.

In meeting the “best execution” obligation, an adviser must execute securities transactions for clients in such a manner that the clients’ total cost or proceeds in each transaction is the most favorable under the circumstances. In assessing whether this standard is met, an adviser should consider the full range and quality of a broker’s services when placing brokerage, including, among other things, execution capability, commission rate, financial responsibility, responsiveness to the adviser, and the value of any research services provided. That’s a fairly fuzzy standard.

One of the landmark decisions in this area was an administrative proceeding against Mark Bailey & Co.(.pdf). Many of the clients were referred by a third party brokerage firm. The clients would tell the firm to keep using the referral brokerage firm for their transactions. The claim was that the firm violated Section 206(2) of the Advisers Act because the firm failed to negotiate lower brokerage commissions. The SEC also took the position that the firm should have been batching transactions to lower brokerage costs and receive a volume discount. The conflict came from perception that the firm was willing to pay the higher commission to the broker in exchange for continuing referrals from the broker.

A recent case highlighted the conflict when an investment adviser is also affiliated with a fund platform. The SEC brought a case against Manarin Investment Counsel Ltd. and Roland R. Manarin claiming they violated their obligation for “best execution” by selecting higher cost mutual fund shares for the three fund clients even though cheaper shares in the same funds were available. The three funds were advised by Manarin and an affiliate of Manarin served as the broker for investments by the funds.

The SEC claims that Manarin consistently purchased Class A shares with higher fees paid to the affiliated broker instead of institutional shares that would have a lower fee structure.  In effect, this case highlights the need to look at the various classes of mutual fund shares available as part of best execution, not merely the brokerage cost involved. In this case, the conflict was heightened because the higher fees were going to an affiliate of the adviser.

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Image is Marie Antoinette’s execution in 1793 at the Place de la Révolution