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Directed Brokerage Agreements

Directed Brokerage Agreements: An Overview

Directed Brokerage Agreements (DBAs) are contractual agreements between investment managers and broker-dealers. This agreement enables investment managers to direct trade executions to specific broker-dealers in exchange for certain benefits, such as research services.

DBAs are often included in the investment management agreement (IMA) between the investment manager and the client. This means that the client`s assets are directed to the designated broker-dealer for trade execution and other services.

Benefits of DBAs

Directed Brokerage Agreements provide several benefits to both investment managers and their clients:

1. Enhanced Research Services

DBAs enable investment managers to access research services from broker-dealers that specialize in certain industries or securities. This access to specialized research helps investment managers make better-informed investment decisions.

2. Cost Savings

DBAs enable investment managers to negotiate lower commission rates with the designated broker-dealer in exchange for directing a specific volume of trades to them. This can lead to significant savings for clients, as lower commission rates translate to lower transaction costs.

3. Transparency

DBAs enable clients to have greater transparency in the fees they pay for investment management services. The agreement outlines the specific benefits the client will receive for directing trades to the designated broker-dealer. This transparency helps clients make more informed decisions when selecting investment managers.

DBAs and Best Execution

DBAs must be structured to ensure best execution, which means that trades must be executed at the best available price for the client. Investment managers must have a process in place to evaluate the quality of trade executions and regularly monitor the designated broker-dealer.

The SEC has provided guidance to investment managers on best execution, which includes evaluating the quality of trade executions, the costs involved, and the broker-dealer`s ability to execute trades in a timely manner.

DBAs and Conflicts of Interest

DBAs have been subject to increased scrutiny by regulators due to potential conflicts of interest. Investment managers must disclose any conflicts of interest to clients and ensure that the DBA is structured to comply with regulatory requirements.

In 2018, the SEC issued a no-action letter to the Investment Adviser Association (IAA), which clarified that investment managers can use DBAs to access research services, provided they comply with certain conditions, such as disclosing conflicts of interest and regularly evaluating the quality of trade executions.

Conclusion

Directed Brokerage Agreements can provide investment managers and their clients with cost savings, enhanced research services, and greater transparency in the fees they pay. However, investment managers must ensure that the DBA is structured to comply with regulatory requirements and ensure best execution. Clients should also be aware of potential conflicts of interest and ensure that the investment manager has disclosed any conflicts of interest.

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