On July 11, 2018, the Office of Compliance Inspections and Examinations (“OCIE”) released a risk alert regarding the most common deficiencies that the staff has cited in recent examinations of advisers’ compliance with their best execution obligations under the Investment Advisers Act of 1940 (the “Advisers Act”). Best execution, in accordance with the guidance provided by the staff of the U.S. Securities and Exchange Commission (“SEC”), requires an adviser to “execute securities transactions for clients in such a manner that the client’s total costs or proceeds in each transaction are the most favorable under the circumstances.” Also in accordance with the guidance, advisers should consider the “full range and quality of a broker-dealer’s services including, among other things, the value of research provided as well as execution capability, commission rate, financial responsibility, and responsiveness to the adviser.”
Most Common Deficiencies
The most common deficiencies noted by the staff include:
- Many advisers are unable to evidence or demonstrate that they are conducting periodic and systematic evaluations of the execution performance of broker-dealers used to execute client transactions.
- Many advisers are not considering the full range and quality of a broker-dealer’s services, specifically not considering qualitative factors or soliciting input from traders or portfolio managers.
- Many advisers are utilizing a single broker-dealer without conducting any comparison regarding the costs or services available from other broker-dealers.
- Many advisers are not providing full disclosure of their best execution practices.
- Many advisers are not providing full and fair disclosure regarding the use of client commissions in purchasing research, execution, and other services.
- Many advisers are not conducting thorough “mixed-use” analyses with regard to services purchased with client commissions.
- Many advisers do not have reasonable written policies, procedures, and controls regarding the best execution process, or are not following the policies, procedures, or controls that they have in place.
What Should Advisers Do?
ACA recommends that advisers take this opportunity to review their best execution and soft dollar processes. Advisers should ensure that they have written policies and procedures governing the best execution process, and that they can document their compliance with those policies and procedures. Advisers should also consider reviewing their Form ADV Part 2As to ensure that the disclosure contained in response to Item 12 accurately describes the adviser’s brokerage activities, the best execution processes followed, and describing the use of client commissions to purchase services.
FCA Confirms its Proposals for the Extension of the Senior Managers and Certification Regime to All Regulated Firms
Last week, the UK Financial Conduct Authority ("FCA") published papers on the extension of its Senior Managers and Certification Regime (“SM&CR”) to all firms authorized under Financial Services and Markets Act 2000 ("FSMA"). The purpose of extending the SM&CR regime to the financial services industry as a whole, according to the FCA, is to develop a "culture of accountability" at all levels within regulated firms. The regulator believes it will encourage staff to improve standards of conduct at all levels, as well as ensure a greater understanding of individual roles and responsibilities. The intention behind the extension of the regime is to codify the precise roles, responsibilities, and accountability of senior managers with the idea that the resulting "culture of accountability" will, in turn, give all employees the correct incentives to improve their standards of conduct, with management shouldering liability in the event of regulatory breach. The new regime will replace the current Approved Persons Regime (“APER”) and arguably increase the burden on firms by placing more emphasis on the firm’s own assessment of the fitness and propriety of their certified staff.
Advisers with affiliates in the UK who are authorized and regulated by the FCA should consider how they will approach the implementation of the new regime and whether it will have any impact on the US affiliates. The compliance date is anticipated to be December 9, 2019, though this has not been finalized. While the implementation of the new regime is not expected to be overly burdensome given the current requirements and industry best practices, nonetheless, for larger, more complex firms there may be a number of issues for consideration.
For More Information
If you have any questions or would like to discuss how ACA can assist your firm with its best execution compliance responsibilities or the new SM&CR regulations, please contact Damon Zappacosta or your ACA consultant.