Exciting Summer Project — Dig Into Some Sand or Dig Into Your Firm’s Best Ex Process?

The Office of Compliance Inspections and Examinations (OCIE) issued a risk alert July 11 targeting investment advisers’ most common deficiencies with regard to their best execution obligations under the Investment Advisers Act of 1940 (the “Advisers Act”). The release reflects the results of over 1,500 adviser examinations.

In addition to the 30,000-foot items – inadequate policies and procedures, not performing reviews or otherwise failing to follow policies and procedures – OCIE reminds us of some of the underlying considerations of best execution assessment and brokerage practice disclosure. However, we do not see anything novel in this alert. It is not the first time the SEC has issued a risk alert that appears to contain just reminders without adding new content. For example, last September, the SEC issued an Advertising Risk Alert that was a repeat of old information.

Best Ex Refresher

OCIE reemphasized Advisers’ responsibility to seek best execution taking into consideration the circumstances of the particular transaction and the range and quality of the services provided by the broker-dealer. A key component of fulfilling this obligation is for Advisers to systematically assess the execution quality of broker-dealers used on behalf of their clients and that, while there are a range of potentially valid considerations, some consideration should be given to which factors may be more relevant to the particular trade. For example,

  • Execution efficiency – for clients with large orders, Advisers may focus on market impact and confidentiality;
  • Market access – for clients in niche strategies, Advisers may emphasize specialized inventory or handling; and/or
  • Other services –access to research, custody, trading systems, or other efficiencies may play an important role for Advisers in serving their clients.

Some of the areas of deficiency in this regard were found to be inadequate overall due diligence on broker-dealers, a failure to assess any qualitative factors whatsoever during best execution reviews, and failure to incorporate trader and portfolio manager inputs, their perspectives on how a broker-dealer best serves those clients, into the assessment. Another area of deficiency was a failure to seek comparisons from other broker-dealers, a consideration which is particularly important where firms rely predominantly on a single broker-dealer.

The release also emphasizes disclosure in terms of both brokerage practices and soft dollar arrangements. Where certain brokerage practices may present the appearance of a conflict of interest, adequate disclosure calls not only for a clear statement of the practice, but also the conflict introduced by the practice and the potential implications of the practice on clients. This is true whether the potential conflict of interest may be between the firm and its clients, as is the case with soft dollars, or between different groups of an Adviser’s clients, as is the case with a static trade order – where one group of clients systematically trades behind another group.

When OCIE issues risk alerts with new information or as a reminder, it as a warning to firms that this is a priority area for the SEC. Learn from peer deficiencies, take the warning, and re-confirm policies, process and documentation. SEC Compliance Consultants is available to assist you with reviewing your firm’s best execution processes.

Other resources:

OCIE Risk Alert: July 11, 2018
Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers
Interpretive Release Concerning the Scope of Section 28(e) of the Securities Exchange Act of 1934 and Related Matters
Commission Guidance Regarding Client Commission Practices under Section 28(e) of the Securities Exchange Act of 1934