SEC Issues Risk Alert on Compliance Issues Related to Best Execution
July 27, 2018
The staff (the “Staff”) of the SEC’s Office of Compliance Inspections and Examinations recently issued a Risk Alert providing examples of common deficiencies that the Staff has cited in recent examinations of investment advisers’ compliance with their best execution obligations under the Investment Advisers Act of 1940.
- Not performing best execution reviews.
The Staff observed advisers that could not demonstrate that they periodically and systematically evaluated the execution performance of broker-dealers used to execute client transactions.
- Not considering materially relevant factors during best execution reviews.
The Staff observed advisers that did not evaluate qualitative factors, including the broker-dealer’s execution capability, financial responsibility, and responsiveness to the adviser; and advisers that did not solicit and review input from its traders and portfolio managers as part of their best execution reviews.
- Not seeking comparisons from other broker-dealers.
The Staff observed advisers that utilized a single broker-dealer to execute all client securities transactions without seeking comparisons from competing broker-dealers initially and/or on an ongoing basis; and advisers that used a broker-dealer to execute client transactions based solely on cursory reviews of the broker-dealer’s policies and prices.
- Not fully disclosing best execution practices.
The Staff observed advisers that failed to disclose that certain types of client accounts may trade securities after other client accounts trade those same securities and that this practice may impact execution prices obtained for the clients that trade later. Additionally, the Staff observed advisers that, contrary to the disclosure in their brochures, did not review trades to ensure that prices obtained fell within an acceptable range.
- Not disclosing soft dollar arrangements and failing to adequately disclose practices falling outside the Section 28(e) safe harbor.
The Staff observed advisers that did not disclose that certain clients may bear more of the cost of soft dollar arrangements than other clients; and advisers that did not provide adequate disclosure of the adviser’s use of client commissions to pay for products and services that did not qualify as eligible brokerage and research services under the safe harbor in Section 28(e) of the Securities Exchange Act of 1934.
- Not properly administering mixed use allocations.
The Staff observed advisers that did not appear to make a reasonable allocation of the cost of a mixed use product or service according to its use or did not produce support of the rationale for mixed use allocations.
- Inadequate policies and procedures relating to best execution.
The Staff observed advisers that did not have policies relating to best execution or whose policies did not take into account the current business of the adviser, including the type of securities traded by the adviser.
- Not following best execution policies and procedures.
The Staff observed advisers that did not follow their policies regarding best execution review, including seeking comparisons from competing broker-dealers to test for pricing and execution; and advisers that did not allocate soft dollar expenses in accordance with their policies.
In light of the common deficiencies identified in the Risk Alert, advisers should carefully review the adequacy and effectiveness of their policies and procedures designed to address their obligation to seek best execution and review their current disclosures for consistency with trading practices employed by the adviser and its personnel.