ALERT
Investment Management
NOVEMBER 2001
AIMR Trade Management (Best Execution) Guidelines
By Michael S. Caccese*
The Association for Investment Management and Research
(AIMR), the highly influential association of financial
analysts, recently issued proposed guidelines for best
execution of securities transactions, referred to as Trade
Management Guidelines (Guidelines). AIMR has promised
such Guidelines since it issued its Soft Dollar Standards in
September, 1998.
The Guidelines are a compilation of recommended best
practices with respect to the obligations that investment
management firms and other investment professionals
regarding the execution of securities trades and management of
the trading functions. The Guidelines define “best execution”
in terms of the ultimate responsibility of an investment firm to
maximize the value of a client’s account. However, the
Guidelines emphasize that best execution does not necessarily
mean finding the best price for a security, but rather obtaining
the most favorable total cost of each transaction after
considering the particular facts and circumstances of the client
and current market factors. Despite the subjectivity of
whether a trade involves the best qualitative execution, an
investment firm should use reasonable diligence in selecting
brokers and executing trades by developing adequate policies
and procedures governing trade management that seek to
maximize value to the client. The AIMR Guidelines focus on
three areas addressing the concept of best execution:
processes, disclosure and recordkeeping.
PROCESSES
In order to create a standard methodology for seeking best
execution, a firm should establish trade management
policies and procedures that implement a standard trading
framework that best meet each client’s investment needs
and restrictions. This framework consists of working
guidelines and controls to implement adequate processes of
best execution. AIMR recommendations for creating this
framework include:
Establish a Trade Management Oversight Committee.
The Committee should meet on a regular basis to develop,
evaluate and change firm-specific order routing practices.
Implement Firm-wide Trade Management Policies and
Procedures. The procedures need to (i) identify conflicts
of interest resulting from trading activities, (ii) require
disclosure of such conflicts to clients, (iii) include a regular
quality service review for selected brokers, and (iv) adopt
the AIMR Soft Dollar Standards.
Implement a Trade Measurement Process. Processes
should be established that provide for internal and third
party reports and analyses regarding firm trading costs and
execution trends, focusing on the specific trading activity
while considering general market conditions. Information
is analyzed by various time periods, individual brokers,
trading venues and methods, and measured against
appropriate objectives and benchmarks.
Create a Broker Selection Guideline/List. Brokers should
be selected based on various characteristics that may best
satisfy the overall trading needs of each client of the firm
including:
„
Trade Efficiency: the ability to minimize total trading
costs, including maintaining adequate capital,
responding during volatile market periods and
minimizing incomplete trades;
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The level of expertise: the volume of trades handled,
the maximization of price improvement, quick trade
execution, ability to obtain liquidity, methods of
tracking and correcting trading errors and engaging in
after-hours and cross-border trading;
* Michael Caccese is a partner in the Boston Office of Kirkpatrick & Lockhart LLP. He works extensively with investment firms on
compliance issues, including all of the AIMR standards. He was previously the General Counsel to AIMR and was responsible for
overseeing the development of the AIMR Soft Dollar Standards and the initial preparation of the AIMR Trade Management
Guidelines, and other standards governing the investment management profession and investment firms. He can be reached at
617.261.3133 and mcaccese@kl.com.
Kirkpatrick & Lockhart LLP
„
Infrastructure: commitment to technology and quality
of internal trading system;
„
Ad hoc information or services: suggestions to
improve quality of trade executions, access to
proprietary and third party research, and access to
research analysts, broker staff and issuers;
„
Special transaction services: unique trading strategies/
difficult trades, directed brokerage, soft dollar
arrangements, step-outs, custody services, wrap
programs, underwriting syndicate participation and
access to IPO shares.
Ensure that Trading Practices are Consistent with
Disclosure. A firm should closely review any information
describing brokerage arrangements and order routing
practices to ensure that the information is materially correct
and adequately describes the firm’s actual practice.
Disclose Actual and Potential Conflicts of Interest.
Conflicts that warrant disclosure include:
Research obtained through soft dollar arrangements;
Directed brokerage arrangements;
Payments for order-flow arrangements;
IPO shares allocation;
Internalization;
Equity interest in market makers or market centers;
Preferencing of orders;
Step-Outs;
Principal trades;
Investment banking relationships with the issuer; and
Using affiliated brokers to execute trades.
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A broker list created by the firm should consider and include
those brokers that can execute trades at the lowest possible
total cost while still meeting overall client needs. Firms
should consider alternative trading options and technology
developments when creating a list. Also, a firm should adopt
policies permitting the use of non-approved brokers to
execute trades, so long as the procedures provide for adequate
documentation and reporting procedures when such brokers
are used.
Establish Brokerage Target Allocation Plan. A firm should
establish a plan projecting annual trading activity and
compensation paid to brokers on the firm’s approved broker
list. The firm’s Oversight Committee should periodically
compare and reevaluate the projected activity with the actual
trade and commission reports to determine whether there are
opportunities to seek more trading value or to identify
violations of the firm’s trading policies and procedures.
Establish Controls to Monitor and Evaluate Broker
Performance and Execution Quality. A firm should compile
and review (i) quarterly broker trading reports (commissions,
transaction reports, failed trades), (ii) brokers’ audited
financial statements to ensure financial stability, (iii) feedback
from investment professionals and staff in the firm and (iv)
information gathered from the Trade Measurement Process to
identify the trading costs and trends of the firm.
DISCLOSURES
AIMR recommends that a firm’s trade management
practices and conflicts should be clearly disclosed in full,
and such disclosure should be made on a regular basis (no
less frequent then annually). Disclosing the firms trading
policies allows clients to judge a firm’s ability to maximize
client value through efficient and well-maintained
execution procedures. While it is good practice to disclose
a firm’s trading methods and procedures to clients, it is
also required under specific securities laws. AIMR has
provided specific disclosure recommendations, including:
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RECORDKEEPING
In accordance with the purpose of establishing trade
management procedures and controls, a firm should create
an adequate recordkeeping system for trading-related
records, covering: broker-selection, trading system
selection, conflicts of interest, committee materials, broker
commissions, client instructions, and soft dollar practices.
CONCLUSION
The Guidelines are recommendations of practices and
procedures to help a firm achieve best execution for its
clients. They include over 35 specific elements to be
followed to comply with the Guidelines. Individual firms
have different standards of best execution, often defined by
their individual client needs. For this reason, AIMR
recognized that the policies and procedures in the
Guidelines may not best suit every firm.
If you would like to discuss any of these issues, please
contact the author or any of the following K&L Investment
Management lawyers:
Boston
Los Angeles
New York
San Francisco
Washington
●
DALLAS
●
HARRISBURG
●
LOS ANGELES
●
MIAMI
●
617.261.3133
310.552.5071
212.536.3941
415.249.1010
202.778.9302
mcaccese@kl.com
wwade@kl.com
rmarshall@kl.com
rphillips@kl.com
mmissal@kl.com
SM
Disclosing Order Routing Practices. These disclosures
include a description of the information considered in
establishing the trade management process.
BOSTON
Michael S. Caccese
William P. Wade
Richard D. Marshall
Richard A. Phillips
Michael J. Missal
Kirkpatrick & Lockhart LLP
Challenge us.
SM
NEWARK
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NEW YORK
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PITTSBURGH
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SAN FRANCISCO
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WASHINGTON
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This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein
should not be used or relied upon in regard to any particular facts or circumstances without first consulting with a lawyer.
© 2001 KIRKPATRICK & LOCKHART LLP. ALL RIGHTS RESERVED.