What you need to know
In developing policies and procedures for a registered investment advisor ("RIA") a topic that should be addressed is trade errors. To uphold the fiduciary duty owed to clients of your RIA, your policies and procedures should cover how you handle errors that may occur when trading in a client's account.
Should a trading error occur in a client's account managed by an RIA there are critical response items to consider in order to uphold your fiduciary duty. By having these compliance components in place you can then demonstrate to a regulator that you are compliant in this aspect of your overall compliance program.
What is a Trade Error?
The most common trade error is buying the wrong security or the wrong amount. Here are a few other examples of events that are considered trade errors:
- Trading in the wrong client account
- Trading in the wrong direction (buy vs. sell)
- Trading at the wrong price (limit orders, etc)
- Incorrect block trade allocation
- Violation of client account restriction (tobacco, oil, military)
- Violation of client account suitability (aggressive vs conservative)
- Delayed execution of trade instructions
- Duplicate execution of trade instructions
How to handle trade errors
Even if the error does not fit into one of these examples you should discuss any potential or actual trade errors with your CCO to ensure compliance. CCOs should then document the event within their trade error log and save all related documentation for the RIA's books and records. You should then consider communicating with the clients as needed to explain events in their statements or other irregular trading activity. Most trade errors can be resolved prior to settlement by the custodian if they are promptly discovered and communicated.
Reviewing policies and procedures
Advisors should ensure their policies and procedures require the disclosure of trade errors to the CCO and that trade errors are documented in the Advisor's trade error log. The log should also include any related backup or other documentation, that the trade errors are resolved in a way that makes the client whole and absolves the client of consequences of the Advisor's error. Additionally, trade errors should be reviewed at least annually by the CCO or their delegate to ensure that any reasonable changes to the Advisor's business practices that could eliminate future errors is considered for implementation. During this annual review the CCO or delegate should also update the Advisor's trade error policy as needed to ensure it accurately reflects how trade errors are resolved.
What are the next steps for a CCO?
To ensure that you have a compliant trade error policy and procedure AdvisorAssist recommends the best practices of:
- Ensure any trade errors are documented in your firm's trade error log
- Keep documentation related to any trade errors as needed to demonstrate the error and its resolution
- Remain aware of any changes to trade error policies and procedures that may be imposed by your custodian and update your internal policies as appropriate
- Communicate your trade error policy and procedure to your supervised persons involved in trading activities
- Complete an annual risk assessment to review your trade error policy and procedures
- Complete an annual review of your trade error log to ensure errors are documented and resolved according to your policy and procedures
The AdvisorAssist CCO Series is a collection of blog posts that cover each of the elements of your RIA's compliance program. Each post will provide an overview of one compliance topic, including our insights on how regulators view each topic as well as some practical steps to help Chief Compliance Officers address this topic. As always, we would welcome your comments and thoughts.