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.”