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Investment advisors and broker-dealers have a duty to seek the best execution of securities transactions for their clients. This article describes some best practices that advisors and broker-dealers can follow to help them meet their best execution duties.
While common law agency principles and fiduciary obligations drive best execution duties, advisors and broker-dealers meet them in different ways. An advisor’s best execution obligation is based on a client’s total transaction cost, including the commission that the client pays the broker-dealer who executes the transaction. A broker-dealer’s best execution obligation, on the other hand, focuses on the price at which an order is executed in the marketplace.
Best Execution for Investment Advisors
The best execution requirement for investment advisors comes from an advisor’s fiduciary responsibility to act solely for the benefit of its clients in all matters covered by their business relationship and not for the advisor’s own interests. As part of this general obligation, investment advisors must seek to execute securities transactions for their clients in a manner (or under terms) most favorable for the client and reasonably available under the circumstances.
According to the SEC, “best execution” is the execution of transactions for clients in a manner designed to ensure that “the client’s total cost or proceeds in each transaction is the most favorable under the circumstances.” This comes down to seeking the best price for a security in the marketplace as well as ensuring that, in executing client transactions, clients do not incur unnecessary brokerage costs or charges.
Look Beyond Execution Price and Commission Rates
An advisor must determine whether executing a client’s transactions in this manner is the best available option, at the particular time, and under the particular circumstances. Therefore, whether an advisor is obtaining best execution for his clients cannot be determined just by looking at the execution price or commission rates being charged to an account or on a specific trade. An advisors is not obligated to get the lowest possible commission but does need to determine whether the transaction is being executed in the best manner for the client.
Review Broker Services
To satisfy best execution responsibilities, an advisor must periodically review both quantitative and qualitative elements of a broker’s services. The quantitative analysis looks at the price at which an order is executed and commission rates.
In the qualitative analysis, the advisor should carefully examine the following characteristics of a broker-dealer, including:
- financial stability,
- access to markets,
- execution and operational capabilities and overall ability to handle complex trades,
- knowledge of and access to market participants,
- ability to commit capital,
- ability to borrow securities for short sales,
- overall knowledge of the market,
- value of research provided,
- reliability in executing trades and keeping records, and
- reputation within the industry.
Avoid Conflicts of Interest
An advisor must consider any actual or potential conflicts of interest when using or recommending broker-dealers to its clients. These may include using affiliated brokers on an agency or principal basis, directing trades to broker-dealers in return for various benefits (e.g., client referrals, soft dollars), trade aggregation and allocation policies, and side-by-side management of different categories of client accounts.
Best Execution for Broker-Dealers
Broker-dealer best execution responsibilities focus on market price. The duty of best execution requires a broker-dealer to seek the most advantageous terms for its customers’ orders reasonably available under the circumstances.
In meeting their obligations, broker-dealers are not required to analyze each order individually. This would not be practical, especially for large volumes of orders, a fact that even the U.S. Securities and Exchange Commission (“SEC”) has recognized.
To ensure that they are meeting their best execution responsibilities, broker-dealers are still required to review their best execution practices on a regular basis. This includes examining their best execution practices in light of market and technology changes to better enable their clients to get the best reasonably available prices.
Best Execution at Interactive Brokers
One broker who been a consistent leader in best execution for several years is Interactive Brokers. Learn more about Interactive Brokers