As fiduciaries, investment advisers are obligated to seek the best execution of securities transactions for clients. Like most fiduciary obligations, best execution involves having policies and procedures in place to regiment business practices that reliably serve the client's best interests and demonstrate compliant conduct.
The recently concluded administrative proceeding by the Securities and Exchange Commission (In the matter of Goelzer Investment Management Inc. and Gregory W. Goelzer) provides an instructive case study of best-execution obligations and the consequences of failure to meet them.
Four questions frame this examination. First, what does best execution require? Second, how should a responsible fiduciary go about meeting the requirements? Third, whose job is it to make sure the best-execution obligation is fulfilled? And, fourth, what are the consequences if it is not?
The best-execution obligation is straightforward. The SEC simply requires investment advisers to “execute securities transactions ... in such a manner that the clients' total cost or proceeds in each transaction is the most favorable under the circumstances.” SEC guidance clarifies the phrase “under the circumstances” by instructing advisers to “consider the full range and quality of a broker's services ... including, among other things, execution capability, commission rate, financial responsibility, responsiveness to the adviser, and the value of any research services provided.”
In the Goelzer case, GIM operated two businesses, an investment advisory practice with approximately $700 million in assets under management and a broker-dealer business that primarily supported the investment advisory business. According to the record of the SEC's administrative proceeding, GIM's ADV Part II disclosed that most transactions for advisory clients would be executed through the company's own broker-dealer in a manner “consistent with its obligation to obtain best price and execution.” The ADV also disclosed the inherent conflict of interest involved in offering advisory services and directing transactions to its own broker-dealer but recommended that arrangement due to advantages in trade cost and quality, reporting and record keeping, products offered, and the overall ability to meet the needs of clients.
An acknowledgement of the best-execution obligation that is not backed by specific policies and procedures to fulfill it consistently is neither effective nor compliant. In Goelzer, the SEC found that “GIM misrepresented in its Form ADV ... that it considered a list of factors and conducted comparative brokerage firm commission rate analysis before recommending itself as broker for its advisory clients, when in fact GIM failed to perform any such analysis.” In addition, the SEC determined that while GIM asserted that clients could benefit from lower commission costs because GIM would aggregate trades, the firm did not deliver that benefit.
CHIEF COMPLIANCE OFFICER
Accountability for ensuring that best-execution policies and procedures are in place and are being followed is the responsibility of the chief compliance officer. In this case, Gregory Goelzer served as both chief executive and CCO of GIM, and both he and the firm were named as respondents.
In the end, the respondents offered to settle the case without admitting or denying the findings, and the SEC accepted the offer. While the consequences were significant, the SEC gave favorable consideration to prompt remedial actions undertaken by GIM during the SEC investigation, including the hiring of a compliance consultant.
In addition to implementing policies and procedures recommended by the compliance consultant and adhering to all regulatory obligations, GIM was ordered to separate the role of CCO from other officer positions for no less than five years.
Best execution may not be a complex area of responsibility but, as this case shows, it does demand careful attention. Guidance from the SEC calls for CCOs to take an activist approach to the firms' compliance programs with continuing reviews to assure that policies and procedures are effective and evolve to address changing circumstances. Trading practices, including satisfying the duty of best execution, have been identified by the SEC consistently as a critical area of focus for SEC examiners, particularly in regard to dually registered or affiliated firms. In short, best execution is expected to be consistent with the overarching fiduciary obligations to the client.
Blaine F. Aiken is president and chief executive of fi360 Inc.
