Government Relationships with Securities Dealers

Finance officers, treasurers and investment officers (hereafter referred to as government investors) who manage and invest public funds place billions of dollars in the fixed-income and money markets on a daily basis. They have a fiduciary responsibility to protect public funds, to always act in the best interest of their entity, to maintain safety and an appropriate level of liquidity and to attain a competitive return on their portfolio.

Generally, access to the securities markets is made through securities dealers who are registered broker/dealers and through financial institutions (banks) with broker/dealer subsidiaries. The fiduciary responsibilities of a government investor include ensuring that:

• reasonable comparisons are made to judge the appropriateness of all investments;
• securities meet the criteria established in the investment policy, including liquidity, diversity and risk of investments;
• security transactions are made on a best execution basis through a competitive process;
• the counterparty to the transaction will fulfill all of its obligations; and,
• the securities are properly safe-kept at a qualified custodial agent in a segregated account. 

It is important to note that brokers/firms may have unique strengths that may provide exceptional value within a specific category of investments, provided that you understand the security that you are purchasing, it dovetails with your investment policy, and you are aware of the risks associated with the transaction.  A unique strength may compliment the skills and abilities of other approved brokers/firms. 

Communication with broker/dealers for the purposes of discussing market conditions, reviewing investment strategies and transacting a trade often occurs by phone, e-mail, or fax.  Regardless of the method of communicating with a broker, a government investor needs to perform due diligence on all securities dealers prior to adding them to their list of approved brokers/dealers for transacting trades. 

1. All securities are held in a third party bank separate from the broker/dealer that is transacting business.
2. Use a defined internal process to select, qualify, renew, or terminate brokers and dealers:
   • Use a questionnaire, conduct an interview, and/or conduct peer references to help determine that the broker understands the public entity's needs/objectives.
   • Determine that the broker is actively involved in the market sectors utilized by the government entity.
   • Select a number of brokers suitable to the entity, allowing for appropriate competition/service on all transactions, while limiting it to a manageable number.
   • Require security brokers and dealers to comply with the Federal Reserve Bank of New York's capital adequacy guidelines  or SEC Net Capital Rule as a condition of doing business. Obtain annual financial reports of the securities firm.
   • Require that brokers provide written acknowledgement or certification of their review and understanding of the government entity's investment policy to assure compliance with its objectives, portfolio risk constraints, and investment trading requirements. 
   • Record and retain pertinent information on the firm and the individual broker including an annual review of the Central Registration Depository (CRD®) information for both maintained by the Financial Industry Regulation Authority (FINRA).  Violations or sanctions imposed by a regulatory agency or government should be carefully reviewed for termination of relationship.
   • Establish parameters that guide periodic review and potential termination of a broker dealer relationship.
   • Do not select or approve more broker/dealers than will be reasonably used. It is better to develop good relationships with a small number of approved dealers than to have a long list of firms who transact little or no business with the investing entity.
3. Due diligence on broker/dealers should include obtaining information on:
   • a security dealer's experience and knowledge of public funds investing;
   • all contact information for the primary contact, backup and operations staff;
   • a broker's manager and supervisor;
   • the financial strength of the firm;
   • areas of expertise and trading activity;
   • registration with FINRA and any citations;
   • the names and contact information for references similar to the entity; and
   • potential conflicts of interest.
4. Establish a competitive procedure for attaining reasonable market rates on investment transactions:
   • Require that all security sales be made through a competitive bid process. If possible, use a competitive offer process on purchases as well.
   • Securities sold through a selling group at a set price (usually par) or available for specific bidding should be compared to comparable maturity securities as part of the competitive process to determine the best relative value.
5. Require that all security transactions be settled on a delivery versus payment basis at the entity's custodian bank to perfect ownership under a written custodial agreement.
6. Retain complete transaction documentation for audit trail purposes including trade tickets, confirmations and safekeeping receipts.
7. Electronic trading platforms, such as Bloomberg and Tradeweb, are becoming another alternative to competitive pricing.  These platforms can provide improved transparency over competitive bids and should be considered if cost effective for the government.  It is still important to have a broker assigned to the account on the electronic platforms so that contact can be made if necessary.  The same due diligence should be completed with all broker dealers on the electronic platforms.
8. Follow all state and entity ethics policies when dealing with all broker/dealers and investment vendors.