SEC Issues Risk Alert on Best Execution: Drinker Biddle

401k, retirement, regulation, Drinker Biddle

Code Red, people.

The Office of Compliance Inspections and Examinations (OCIE) of the Securities and Exchange Commission identified common deficiencies cited in recent examinations of over 1,500 investment advisors in a risk alert, published on July 11.

The risk alert identifies common deficiencies relating to advisors’ compliance with their best execution obligations under the Investment Advisers Act of 1940 (the Advisers Act).

This risk alert provides a general background on best execution obligations for investment advisors and outlines the common deficiencies detailed in the risk alert.

Background on Best Execution

Under the Advisers Act, investment advisors selecting broker-dealers for executing client trades have an obligation to seek to obtain “best execution” of client transactions, taking the circumstances of the particular transaction into consideration.

OCIE noted in the risk alert that the determinative factor in the best execution analysis is whether the transaction represents the best qualitative execution for the managed account, rather than whether the transaction has the lowest possible commission cost.

Soft dollar arrangements may also impact an advisor’s analysis of best execution, particularly those arrangements entered into under Section 28(e) of the Securities Exchange Act of 1934 (the “Exchange Act”), which provides a safe harbor that allows advisors to pay more than the lowest commission rate available for a trade under certain conditions without breaching their fiduciary obligations to clients.

The risk alert also reinforces the need for specific disclosures directly related to these and any other potential conflicts.

Identified Deficiencies Relating to Best Execution

The risk alert identified the following deficiencies relating to advisors’ best execution obligations:

Practice Points and Tips

OCIE closes the risk alert by advising that “OCIE encourages advisors to reflect upon their own practices, policies, and procedures in these areas and to promote improvements in advisor compliance programs.”

The SEC’s follow-up efforts regarding its risk alerts, however, have evolved significantly to become much more than encouragement and promotion. For example, in July 2016, OCIE issued a risk alert titled “OCIE’s 2016 Share Class Initiative.”

Approximately 18 months later, the SEC’s Division of Enforcement (“Enforcement”) announced its “Share Class Selection Disclosure Initiative.” By way of further perspective, the number of best execution cases filed by Enforcement against advisors has increased over the past several years.

Advisors should view this risk alert as the SEC putting them on notice of increasing OCIE and SEC Enforcement scrutiny of advisor best execution.

Advisors may consider, therefore, conducting assessments of their best execution policies, procedures and practices, and disclosures to clients in a manner that aligns with the guidance in the risk alert, as well as documenting these efforts.

James G. Lundy is a partner with Drinker Biddle & Reath LLP. Kellilyn Greco is an associate with the firm.

Exit mobile version