PLANADVISER - January/February 2022 - 39

compliance consult
David Kaleda
Best Execution Standard
Professionals must meet this bar, to apply PTE 2020-02
REGISTERED broker/dealers (B/Ds) and investment advisers
have long been required to comply with a " best execution "
standard when making trades for their clients. That
obligation is now one of the conditions a financial institution
and financial professional must meet to take advantage
of the Department of Labor (DOL)'s
Prohibited Transaction Exemption (PTE)
2020-02. The failure to meet the standard
will result in the loss of exemptive relief.
Therefore, firms should be looking at
their current best execution policies and
procedures and how those should be coordinated
with their PTE 2020-022 compliance
efforts.
The fiduciary standards in Section 203
of the Investment Advisers Act of 1940,
according to the Securities and Exchange
Commission (SEC), establish a best execution
requirement. Advisers must select
broker/dealers through which trades on
behalf of clients will be executed in a
manner that helps ensure that the client's
total costs or proceeds in each transaction
are the most favorable under the circumstances.
Further, Financial Industry Regulatory Authority
and procedures in place to promote compliance with those
applicable standards. Thus, if the firm and its representatives
comply with these policies and procedures, and thus
with applicable best execution standards,
they should
meet the PTE 2020-02 condition.
However, the reality is that not all
" ... the reality
is that not all
firms have
sufficient
policies and
procedures
in this regard. "
(FINRA) Rule 5310 imposes a best execution standard on
registered broker/dealers. Brokers must use reasonable diligence
to determine the best market through which a trade
should occur and to establish that this transaction is made
at a price as favorable as possible under the prevailing
market conditions. The Municipal Securities Rulemaking
Board (MSRB) also imposes a best execution standard-on
trades involving municipal securities.
Now, firms need to consider that a condition of PTE
2020-02 is that the representative and firm: 1) do not receive
more than reasonable compensation, and 2) do " seek to
obtain the best execution of the investment transaction
reasonable under the circumstances. " Notably, these two
requirements are distinct. The first addresses how much
the firm and representative get paid, while the second
addresses the cost to the client of executing the trades.
The DOL clarifies in the preamble to PTE 2020-02 that
the representative and the firm meet this best execution
condition if they meet the applicable SEC, FINRA and
MSRB best execution requirements. This should be good
news to firms, because they already should have policies
firms have sufficient policies and procedures
in this regard. Additionally, not all
representatives follow otherwise sufficient
policies and procedures. These facts are
well-known to compliance officers responsible
for verifying ongoing compliance and
to the SEC and FINRA, which investigate
these practices.
In such circumstances,
the firms most often improve their policies,
procedures and compliance activities to
better ensure compliance in future trades.
Trades may be adjusted but certainly not
in every case.
On the other hand, if a firm or representative
relies on PTE 2020-02, a prohibited
transaction has likely occurred by
reason of that entity failing to comply
with one of the exemption's conditions. In that case, something
needs to be done to address the prohibited transaction.
Indeed, PTE 2020-02 provides a self-correction mechanism
that would require, among other things, some sort
of remedial action-e.g., making the client whole for any
investment losses, and self-reporting the violation to the
DOL. PTE 2020-02 does not provide for a de minimis or materiality
threshold here.
If a firm and its representatives intend to rely on PTE
2020-02, they should think about the effectiveness of
their current best execution policies and procedures and
whether those in fact meet applicable SEC, FINRA and
MSRB requirements. They should also consider how they
will remedy violations of these policies and procedures,
particularly in light of the PTE's self-correction requirements.
This situation is a clear example of where the securities
compliance and Employee Retirement Income Security
Act (ERISA) compliance worlds collide, particularly as
the DOL moves to take a more active role in regulating the
activities of advisers and broker/dealers.
David Kaleda is a principal in the fiduciary responsibility practice
group at Groom Law Group, Chartered, in Washington, D.C.
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PLANADVISER - January/February 2022

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