October 31, 2019

CCO Series - Trade Errors

What You Need to Know

In developing policies and procedures for a Registered Investment Advisor ("RIA") a topic that must be addressed is trade errors. To uphold the fiduciary duty owed to clients of your RIA, your policies and procedures must cover how you handle errors that may occur when trading in a client's account. If a trading error occurs in a client's account managed by an RIA there are critical response items to consider in order to uphold your fiduciary duty. Implementing these compliance components can demonstrate to a regulator that you are satisfying your regulatory requirements.

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 must discuss any potential or actual trade errors with your CCO to ensure compliance. CCOs should document the event within their trade error log and save all related documentation for the RIA's books and records. 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 must 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 must 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 delegate to ensure that any reasonable changes to the Advisor's business practices that could eliminate future errors are considered for implementation. During this annual review, the CCO or delegate must 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?

Sample review transactions from your firm’s trading blotter to ensure trades are placed accurately in accordance with documentation and client objectives. Ensure any and all trade errors are documented in your firm's trade error log. Confirm that trade error files maintain documentation related to the specifics of the trade error as well as documentation substantiating the resolution. Consider reasonable changes to business practices that could eliminate the potential for future errors. Finally, remain aware of any changes to trade error policies and procedures that may be imposed by your custodian and ensure your internal policies remain accurate. Ensure proper communication of trade error policies and procedure to supervised persons.

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.

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