RIA Compliance and Practice Management Blog

SEC Risk Alert Flags Most Common RIA Best Execution Compliance Issues

Posted by RIA in a Box

Jul 12, 2018 12:34:35 PM

July 2018 SEC RIA Risk Alert: best executionOn July 11, 2018, the Securities and Exchange Commission ("SEC") Office of Compliance Inspections and Examinations ("OCIE") released a new National Exam Program Risk Alert outlining the most common compliance issues related to the registered investment adviser ("RIA") regulatory requirement to seek to obtain "best execution" for client transactions. SEC OCIE staff notes, "an adviser must execute securities transactions for clients in such a manner that the client’s total costs or proceeds in each transaction are the most favorable under the circumstances." In particular, this risk alert provides examples of the most common regulatory compliance deficiencies related to the best execution requirement as observed by SEC OCIE staff during recent regulatory examinations.

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In this latest risk alert, SEC OCIE staff reiterates, "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 managed account." Furthermore, the staff highlights, "Under Section 28(e) of the Securities Exchange Act of 1934 (the “Exchange Act”), an adviser may pay more than the lowest commission rate in soft dollar arrangements without breaching its fiduciary obligation, provided that certain specified conditions are met." Soft dollars are “brokerage and research” services obtained by an investment adviser from its broker dealer / custodian in exchange for client commissions.

Some of the highlighted issues related to best execution lead to the following questions for the firm's Chief Compliance Officer ("CCO") to consider when evaluating and testing the firm's compliance program related to the fiduciary obligation to seek and obtain "best execution":

  • Performing Best Execution Reviews
    • Does the firm perform regular best execution reviews of broker-dealers used to execute client transactions?
    • Are such reviews properly documented?
  • Considering Materially Relevant Factors During Best Execution Reviews
    • Are qualitative factors such as a broker dealer's execution capability, financial responsibility, and responsiveness to the adviser being considered?
    • Is the firm's CCO soliciting input from the relevant traders and portfolio managers when conducting the review?
  • Disclosing Best Execution Practices
    • If relevant, is the firm disclosing that certain types of client accounts may the trade the same securities after other client accounts and how this practice may impact execution prices?
    • Is the firm reviewing trades to ensure proper prices were obtained per the firm's disclosures?
  • Disclosing Soft Dollar Arrangements
    • Are soft dollar arrangements fully and adequately disclosed?
    • If certain clients bear more of the cost of soft dollar arrangements is the practice properly disclosed?
    • If the firm receives soft dollar benefits that do not qualify as eligible brokerage and research services under the Section 28(e) safe harbor, is this practice properly disclosed?
  • Establishing Proper Policies and Procedures
    • Does the firm have policies related to best execution in the compliance manual?
    • Are policies established and implemented to monitor broker-dealer execution performance?
    • Are policies properly addressing all the types of securities traded by the firm?
  • Following Policies and Procedures
    • Is the firm performing its best execution review as outlined in the compliance manual?
    • Is the firm allocating soft dollar expenses as outlined in the compliance manual?
    • Is the firm performing ongoing monitoring of best execution as specified in the compliance manual?

We highly recommend that the CCO and all advisory firm principals carefully review this latest SEC RIA compliance risk alert. Failure to address potential best execution issues can lead to serious compliance issues. In addition, firms should take this opportunity to do the following:

  • Review the firm's Form ADV to ensure that full and accurate disclosures related to best execution and soft dollar arrangements are being made that match the firm's current practices
  • Review the firm's policies and procedures to ensure that all potential best execution issues as outlined in this latest risk alert are properly captured in the firm's compliance manual 
  • Consider revamping the firm's best execution review and testing processes to include more robust comparison against competing broker-dealers
  • Review current internal documentation to ensure that all previous best execution reviews have been properly conducted and documented

Firms may also want to consider how the best execution requirement can impact mutual fund share class selection given that mutual fund share class selection remains an RIA regulatory area of focus.

Be sure to check back soon as we continue to provide updates on relevant RIA regulatory compliance focus areas.

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Topics: RIA Operations, RIA Compliance

RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

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