Fund Managers: Document Best Execution Practices and Choices

This blog post was previously published on August 16, 2019. It was updated on January 16, 2020.

SEC encourages RIAs to look beyond cost of trades

As a registered investment adviser, you are a fiduciary to your client, which requires you to act in your client’s best interests. As part of its 2019 and 2020 examination priorities, the Securities and Exchange Commission (SEC) is emphasizing best execution on transactions that all registered investment advisers, including fund managers, perform.  

So what does best execution look like for fund managers? 

In the past, the cost of the trades that funds execute was the primary factor in determining best execution. More recently, though, the SEC has made it clear that other factors must also be considered. It has also made it clear that funds must thoroughly compare their options for executing trades, both initially and on an ongoing basis.  

Factors in best execution

Best execution takes into account: 

• Price of the trade 
• Size of the order 
• Speed of execution 
• Ability of the execution agent, broker-dealer, or exchange to complete the transaction 
• Trading characteristics of the security 
• Availability of accurate information comparing markets 
• Technology to process data about markets 
• Availability of access to competing markets and the cost of access 
• A potential execution agent’s responsiveness to the fund’s team 
• Execution agent’s fiscal responsibility and overall reliability 

SEC examiners are likely to expect fund managers to evaluate their broker-dealers’ order handling through the lens of best execution. This may include looking at total costs or proceeds for the order, the broker-dealer’s execution capabilities, soft dollar arrangements and other conflicts of interest, pricing, commission rate, reliability, responsiveness, and other factors.  

Best execution requirements certainly apply when managers are making decisions directly, but the SEC also expects fund managers to review their automated execution choices at least quarterly, to ascertain whether they continue to provide best execution.  

While funds tend to seek out and use best execution methods, they don’t always document their work with data and reporting – and this is one area where problems can come up during a routine SEC examination. The SEC wants you to be able to demonstrate, through documentation or other means, that you evaluated execution options and chose the one that would be most beneficial to the fund (and, therefore, its investors).  

Document best execution practices

Several practices can help you to back up your best execution choices: 

• Develop a written policy for determining best execution, and include documentation requirements. Keep it up to date.  

• Educate staff who may be involved in execution choices – from the most junior to the most senior – on the policy and the thinking behind it.  
• Develop a framework for documenting the steps you’ve taken to determine best execution. This may be as simple as a checklist or a form that you fill out each time you make a decision or evaluate automated execution systems. Include use of the new information available about National Market System (NMS) broker-dealer order handling as part of your documentation process.  
• Train staff in documentation practices and communicate to them that these practices protect them.  
• Use internal monitoring – both technological and human – to see whether everyone is following and documenting best execution practices.  
• Take extra care with cross trades, making sure to properly execute and document them. These are legal as long as they conform to best execution requirements, benefit holders of both funds, are properly disclosed, and the client has agreed to them. 

• Utilize portfolio management platforms’ tools for pre-trade and post-trade research, and retain a record of the information you uncover – even if it’s just a PDF or a screenshot.  
• Disclose best execution practices that you may use in the fund manager’s brochure, also known as Form ADV Part 2A. 
• Update fund documents to reflect current business practices. 
• Have a third-party consultant review fund documents and practices prior to the end of the year, to help you understand whether they are in alignment.  

Contact me or another member of Kaufman Rossin’s investments industry group to learn more about the SEC’s current priorities and how your fund can stay in compliance.