SEC Steps Up Vigilance of Best Execution
June 26, 2000
NEW YORK - While there are no clearly defined compliance standards for best execution trade practices, firms that do not use electronic commerce networks to conduct any of their trades raise SEC concerns, according to an SEC official.
"[Trade] costs using ECN's are traditionally lower," said Gene A. Gohlke, associate director of the SEC's office of compliance, inspections and examinations. "Even big advisers use them for some of their smaller trades. There might be some reason why a company isn't using [an ECN] but those need to be explained." Gohlke spoke at a seminar here last week sponsored by Glasser Legal Works of New York.
A company's failure to use electronic commerce networks could elicit further investigation, said Gohlke. Best execution is an issue that has caught the attention of the SEC and enforcement proceedings will be used to encourage best execution practices, Paul Roye, director of the SEC's division of investment management, said recently.
"There will probably be some guidance on best execution," he said. "But it will take the form of enforcement actions." Roye spoke at a conference sponsored by the American Legal Institute and American Bar Association in Boston earlier this month.
Roye's statements follow an SEC "tour" of firms that examined firms' trading policies, said Gohlke. Although the visits were designed to help make advisers' portfolio management teams and trading desks aware of some of the SEC's concerns regarding best execution policies, most of the visits included the presence of nervous lawyers, Gohlke said.
Even the SEC has a hard time defining best execution practices, Gohlke said. The SEC plans to issue a report on best execution that will outline some best practices, he said.
"But, we can't give you a formula that gives you a surefire way to be in compliance," he said.
Firms should be wary, however of any quid pro quo arrangement with a broker or broker/dealer that does not serve the best interests of the client, he said. Any relationship with a broker or a broker/dealer that benefits the firm in any way represents a potential conflict of interest, he said.
Another red flag the SEC will be looking for are blocks of trades that are unbundled or split up among several different brokers and broker/dealers, he said.
Because there are no established standards for what constitutes best trade execution, firms need to have a process in place that can identify and evaluate potential gray areas in a firm's trading policies, Gohlke said. He recommended that a procedure be incorporated into the order placement process and involve portfolio managers, traders and back offices.
It is vital that senior management is aware of procedures and makes best execution a priority, Gohlke said. In-house assessments should be made on a quarterly basis and each firm should have an approved list of broker/dealers it works with, he said.
When assessing whether a firm is in compliance in its best execution practices or if there are potential liabilities, compliance officers should question whether clients benefit from any given relationship with a broker or broker/dealer. They should also determine whether its practices are consistent with its disclosures.
An internal audit system that insures a firm is in compliance is a good idea, said Frank V. Knox, vice president and ethics and compliance officer for Fidelity Investments of Boston.
"More than an internal audit system, the SEC wants to see a system to follow through on your internal auditing procedures and what is done with the internal audit findings," he said.
Knox said he was concerned that the SEC may find fault with a company between the point a company documents its deficiencies and has time to correct them.