lightbulb efficient

Content provided by Marc Pfeffer, CLS Senior Portfolio Manager

Best execution, put simply, is an advisor’s obligation to get optimal results for client transactions. Although not defined in securities law, industry professional groups, such as U.S. Compliance Consultants, have defined “best execution” to include “execut[ing] 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.”

So how do we ensure best execution?

The following summarizes the advice of Brian DeDonato, CAIA and Larry Cowen, Esq., authors of the recent guide Practical Compliance & Risk Management: Best Execution.

  • Advisors and broker-dealers are both obligated to seek best execution.
  • For advisors, different investment focuses require different approaches. Advisors who invest in ETFs and mutual funds may rely on outsourced trading platforms. Advisors who invest in hedge funds may use an in-house trading function. Both present their own challenges. Relying on a third-party trading platform typically means less control over the selection of executing brokers, and hedge-fund managers may have several executing brokers to track.
  • Watch out for soft dollars: firms that use soft dollars should evaluate “whether total costs for client transactions are justifiable in light of soft dollar credits.”
  • Ways to achieve best execution include:
    • Selecting sell-side* trading partners
    • Analyzing trading venues that receive orders
    • Implementing internal order management and execution systems to manage order flow
  • A best execution committee can be appointed to help implement and review processes.
  • Methods to review best execution may be qualitative-only (internal audits), a combination of qualitative and quantitative (hybrid approach), or quantitative-only (creating a systematic and repeatable process).

The tools available for best execution testing have improved greatly in recent years. Cost-effective internal methods or sophisticated software are options for firms looking for greater transparency. Now that regulators have even more access to data and can better examine a firm’s compliance, it is imperative that advisors implement best practice recommendations, and compliance personnel review SEC enforcement actions diligently.

As the authors note, “Keeping pace with best practices, combined with a keen awareness of where advisory firms have gone awry, is now the new normal when it comes to measuring up against the pack.”

* The financial industry includes a “sell side” and “buy side.” Those on the sell side are involved in creating, promoting, analyzing and selling securities. The buy side includes those who purchase stocks with the objective of selling it later at a profit.
This material does not constitute any representation as to the suitability or appropriateness of any security, financial product or instrument.  There is no guarantee that investment in any program or strategy discussed herein will be profitable or will not incur loss.  This information is prepared for general information only.  It does not have regard to the specific investment objectives, financial situation, and the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.  Investors should note that security values may fluctuate and that each security’s price or value may rise or fall.  Accordingly, investors may receive back less than originally invested.  Past performance is not a guide to future performance.  Individual client accounts may vary.  Investing in any security involves certain non-diversifiable risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk.  These risks are in addition to any specific, or diversifiable, risks associated with particular investment styles or strategies.