An investment adviser (IA) firm uses an affiliated broker-dealer to execute client trades. The IA discloses this relationship to clients in its Form ADV and advisory agreement. However, the IA does not consistently seek competitive bids or periodically compare the affiliated broker-dealer's commission rates and execution quality with those of unaffiliated broker-dealers. Which of the following best describes the IA's adherence to its fiduciary duty regarding conflicts of interest?
- AThe IA is in violation of its duty of best execution and loyalty due to insufficient oversight.
- BThe IA is compliant, provided the affiliated broker-dealer offers the lowest commission rates.
- CThe IA is fully compliant, as disclosure of the affiliated relationship is sufficient.
- DThe IA is only required to disclose the affiliation, not to monitor execution quality.
Show answer & explanationAnswer & explanation
Correct answer: A. The IA is in violation of its duty of best execution and loyalty due to insufficient oversight.
While disclosure of an affiliated relationship is necessary, it is not sufficient. An IA has a fiduciary duty to seek best execution for its clients, which means periodically assessing whether the affiliated broker-dealer's commission rates and execution quality are competitive with those of unaffiliated firms. Failure to do so is a breach of the duty of best execution and loyalty.
Why the other options are wrong
- B. The IA must actively seek best execution, not simply assume the affiliated broker-dealer offers the lowest rates without verification.
- C. Disclosure is necessary but not sufficient; the IA must also ensure best execution despite the conflict.
- D. The duty of best execution requires active monitoring of execution quality and costs, even with an affiliated entity.
IA Conflicts of Interest - Affiliated Broker-Dealer
When an investment adviser uses an affiliated broker-dealer for client trades, it creates a conflict of interest. The IA must not only disclose this relationship but also ensure that it continues to meet its fiduciary duty of best execution and loyalty by periodically comparing the affiliated broker-dealer's services (commissions, execution quality) against unaffiliated options.
- Affiliation is a conflict of interest.
- Disclosure is mandatory but not enough.
- IA must still seek best execution and compare services.
Memory trick: Disclose the link, but still compare, for best execution, be fair!