OCIE Best Execution Risk Alert

Guidance and lessons for private fund managers

Brian T. Daly and Marc E. Elovitz, Schulte Roth & Zabel LLP
Originally published in the July | August 2018 issue

On July 11, 2018, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert [1] focusing on the most common deficiencies relating to best execution found by the SEC staff (“staff”) in recent examinations of investment advisers. The Risk Alert provides a snapshot of OCIE’s expectations regarding a fund manager’s best execution policies and procedures.

The obligation of best execution

An investment adviser’s obligation to seek best execution for client securities transactions is based in an investment adviser’s fiduciary duties. The SEC and its staff have long indicated that an investment adviser must satisfy fiduciary standards of care in selecting brokers for clients, negotiating commissions and compensation terms for clients’ securities transactions, and supervising execution quality.

While the staff’s position that there is a duty of best execution is unambiguous, the factors that an investment adviser may use in evaluating whether its clients are receiving best execution and the relative weights given to the various factors are not fixed or enumerated. In selecting broker-dealers for client accounts and in agreeing to the economic terms of the resulting trading activities, an adviser may take into consideration numerous quantitative and qualitative factors in seeking best execution, including the commission rates, the quality of execution, the research provided to the adviser, the broker-dealer’s financial responsibility and responsiveness to the adviser. [2]

Managers are also permitted, under Section 28(e) of the Securities Exchange Act of 1934, to utilize soft dollars to purchase eligible research and brokerage services from broker-dealers. Section 28(e) allows an adviser to cause a client to pay more than the lowest possible commission rate without violating the adviser’s duty to seek best execution, provided that certain conditions are met, including disclosure of the soft dollar arrangements.

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