Best Execution: Trade Allocation (SEC 206)

To meet the best execution: trade allocation (sec 206) requirement, you need a written, consistently followed process that allocates aggregated trades fairly across clients and prevents favoritism, cherry-picking, or hidden cross-subsidies. Under Advisers Act Section 206, allocation practices that operate as fraud or deceit violate your fiduciary duty. (15 U.S.C. 80b-6; Release No. IA-5248)

Key takeaways:

• Document an allocation methodology, pre-allocation workflow, and exception handling that traders must follow every time. (15 U.S.C. 80b-6; Release No. IA-5248)
• Build supervision that detects allocation drift, manual overrides, and “better fills to preferred accounts.” (15 U.S.C. 80b-6; Release No. IA-5248)
• Keep evidence that shows what happened on each aggregated order: intended allocation, final allocation, and why any changes occurred. (15 U.S.C. 80b-6)

Trade allocation is where “best execution” and fiduciary duty become operational. If you manage multiple accounts and place aggregated orders, you make allocation decisions that determine which clients get fills, what prices they get, and how partial fills and costs are distributed. A weak or inconsistently applied allocation process creates predictable client harm: preferred clients get the best fills, less-favored clients get leftovers, and the adviser benefits by keeping high-performing accounts happy.

Section 206 of the Investment Advisers Act is broad, but it is the hook the SEC uses when an adviser’s allocation approach “operates as a fraud or deceit” on clients. (15 U.S.C. 80b-6) The SEC’s fiduciary standard of conduct interpretation reinforces that an adviser’s duty of loyalty and care requires addressing conflicts and acting in clients’ best interest, which includes trade practices that systematically advantage some clients over others. (Release No. IA-5248)

This page is written for a CCO or GRC lead who needs to stand up a requirement-level control quickly: define allocation rules, embed them into trading operations, and retain evidence that will survive an SEC exam.

Regulatory text

Statutory hook (excerpt): “It is unlawful for any investment adviser to employ any device, scheme, or artifice to defraud any client or prospective client, or to engage in any transaction, practice, or course of business that operates as a fraud or deceit upon any client or prospective client.” (15 U.S.C. 80b-6)

Operator meaning: You must run trade allocation in a way that is fair, consistently applied, and not misleading in effect. If your process (or lack of process) predictably advantages certain clients, strategies, employees, or the adviser itself, the SEC can treat that pattern as a Section 206 violation even without an explicit “trade allocation rule.” (15 U.S.C. 80b-6; Release No. IA-5248)

Plain-English interpretation of the requirement

You are expected to:

• Allocate investment opportunities equitably when you aggregate orders or have limited liquidity, partial fills, or price improvement that cannot be given to everyone.
• Prevent and detect cherry-picking (allocating favorable fills to preferred accounts and unfavorable fills to others).
• Control conflicts created by proprietary interests, employee accounts, performance fee accounts, flagship funds, or accounts that drive business value. (Release No. IA-5248)
• Prove what you did with records that tie the trade decision to the final client outcomes. (15 U.S.C. 80b-6)

Who it applies to (entity and operational context)

Applies to SEC-registered investment advisers and their supervised persons engaged in trading for client accounts where allocation discretion exists. (15 U.S.C. 80b-6; Release No. IA-5248)

Operational contexts where the control matters most:

• Aggregated/block orders allocated across multiple client accounts.
• Partial fills where not all accounts can receive the full intended quantity.
• Limited capacity trades (new issues, small floats, illiquid names, restricted lists).
• Cross trades or internal matching where one client could benefit at another’s expense (if your firm permits them, governance must be tight). (Release No. IA-5248)
• Accounts with different fee arrangements (performance fee vs. asset-based), different liquidity constraints, or different guidelines, which increases allocation complexity and conflict risk. (Release No. IA-5248)

What you actually need to do (step-by-step)

1) Map your allocation universe (so you know where discretion exists)

Create a trade allocation inventory that answers:

• Which strategies/accounts participate in aggregation?
• Which OMS/EMS and brokers are used?
• Who can edit allocations (trader, PM, operations)?
• Where do manual overrides happen (spreadsheet, email, OMS notes)?

Deliverable: “Allocation Universe & Discretion Map” signed off by Trading, Operations, and Compliance.

2) Write an allocation policy that matches real trading behavior

Your policy should be short enough that traders follow it, and specific enough that Compliance can test it. Include:

• Pre-allocation requirement: allocations are entered before execution where practicable (or a defined “as soon as practicable” standard with documentation expectations).
• Default allocation method: pro rata by order size, by account model weight, or another defensible rule that is consistently applied.
• Partial fill handling: how you round, how you treat minimum lots, and how you avoid systematically disadvantaging smaller accounts.
• Price and cost allocation: how average price is assigned, and how commissions/fees are spread.
• Eligibility rules: when an account is excluded (restrictions, cash, guidelines) and how exclusion is documented.
• Exception protocol: who can approve exceptions, what qualifies, and what evidence is required.

Tie policy language to fiduciary principles: fairness, repeatability, and conflict management. (Release No. IA-5248)

3) Embed controls into the OMS/EMS workflow (reduce “policy on paper” risk)

Operationalize with system controls where possible:

• Require pre-allocation fields before order release.
• Lock edits after execution, or force reason codes plus supervisor approval.
• Use standardized allocation templates by strategy.
• Enforce audit trails: who changed what, when, and why.

If you cannot system-enforce, create a compensating control: daily operations review of changes plus documented approvals.

4) Build supervision and testing that detects allocation harm

Set up surveillance that flags patterns consistent with unfair allocation. Examples:

• Accounts receiving a disproportionate share of price improvement.
• Repeated manual overrides for the same account/strategy.
• Same-day reversals where an account regularly gets “better” fills.
• Drift between intended pre-allocation and final allocation.

Document review cadence, escalation, and disposition standards so an examiner sees governance, not ad hoc checks. (15 U.S.C. 80b-6)

5) Disclose the material parts clients need to understand

Your disclosures (Form ADV and client communications where applicable) should be consistent with actual practice on:

• Aggregation and allocation methodology.
• Conflicts that could affect allocation decisions and how you address them. (Release No. IA-5248)

The goal is alignment: what you say you do, what the OMS shows you did, and what clients experienced.

6) Train traders, PMs, and operations with “edge case” scenarios

Training needs to cover real failure modes:

• Partial fills late in the day.
• Hot IPO allocations or scarce liquidity.
• Accounts coming in/out of eligibility due to restrictions.
• Performance fee accounts vs. non-performance fee accounts.
• Model changes mid-day.

Record attendance, materials, and scenario outcomes.

Required evidence and artifacts to retain

Keep artifacts that allow reconstruction of intent, execution, and allocation outcomes:

• Trade allocation policy and procedures, current and prior versions. (15 U.S.C. 80b-6)
• OMS/EMS audit logs: order creation, pre-allocation, executions, edits, timestamps, and user IDs.
• Allocation templates by strategy and change history.
• Exception approvals with rationale and supporting data (email, ticket notes, workflow approvals).
• Daily/periodic allocation surveillance reports and review sign-offs.
• Client disclosure artifacts (Form ADV sections relevant to brokerage practices and trade allocation) and change approvals. (Release No. IA-5248)
• Training materials and completion records for trading and operations.

If you use Daydream to manage control evidence, set the control to require (a) the latest policy, (b) a sample of OMS allocation audit trails, and (c) documented review outputs from the relevant period, so evidence stays exam-ready without a scramble. (15 U.S.C. 80b-6)

Common exam/audit questions and hangups

Expect exam teams to ask for proof that the process is real:

• “Show me how you pre-allocate a block trade and how you handle partial fills.”
• “Who can change an allocation after execution? Show the approvals and audit trail.”
• “How do you test for cherry-picking or favoritism? What did you find and what did you do?”
• “Do your disclosures match your actual allocation approach?” (Release No. IA-5248)
• “Walk me through an exception that happened recently and why it was fair.”

Hangups that slow teams down:

• No single owner for allocation governance (Trading says Ops; Ops says Trading).
• Surveillance exists but has no documented conclusions or escalation trail.
• Exceptions are “handled in email,” then lost.

Frequent implementation mistakes and how to avoid them

Mistake: Policy says “pro rata,” but practice is “PM discretion”

Fix: Either tighten the workflow to enforce pro rata, or revise the policy to match a controlled discretionary method with documented rationale and supervision. Misalignment is where Section 206 risk compounds. (15 U.S.C. 80b-6)

Mistake: No pre-allocation, only post-trade “allocation by spreadsheet”

Fix: Require pre-allocation in OMS for aggregated orders where practicable, and require exception documentation when not practicable. Keep immutable audit trails. (15 U.S.C. 80b-6)

Mistake: Exceptions are common and ungoverned

Fix: Define what qualifies as an exception, require approvals, and track exceptions as a metric for supervisory review. High exception volume is a control failure signal.

Mistake: Surveillance looks only at execution quality, not allocation fairness

Fix: Add fairness testing: intended vs. final allocation, manual override frequency, and outcome-based patterns that indicate favoritism. (Release No. IA-5248)

Mistake: Conflicts are acknowledged but not operationally mitigated

Fix: Where conflicts exist (flagship accounts, performance fee accounts), put added controls in place: tighter approval thresholds, enhanced surveillance, and documented conflict review. (Release No. IA-5248)

Enforcement context and risk implications (qualitative)

Even without a specific “allocation rule,” the SEC can treat unfair allocation as a fraudulent practice under Section 206 if the effect is deceptive or inconsistent with fiduciary obligations. (15 U.S.C. 80b-6; Release No. IA-5248) The operational risk is not limited to enforcement: poor allocation controls also drive client complaints, contractual disputes, and reputational damage because allocation outcomes are easy for sophisticated clients to analyze.

A practical 30/60/90-day execution plan

Day 1–30 (stabilize and document):

• Appoint an accountable owner for trade allocation governance (usually Head of Trading with CCO oversight).
• Inventory where allocation discretion exists and identify manual steps.
• Publish a trade allocation procedure that matches current practice, plus an exception protocol. (15 U.S.C. 80b-6; Release No. IA-5248)
• Start retaining evidence systematically: audit trails, approvals, and review sign-offs.

Day 31–60 (control hardening):

• Implement OMS/EMS guardrails: required pre-allocation fields, reason codes for changes, approval workflow for overrides.
• Stand up an allocation surveillance review with documented outcomes and escalation paths.
• Align disclosures with actual practices and conflict handling. (Release No. IA-5248)

Day 61–90 (testing and sustainability):

• Run targeted testing on a sample of aggregated orders: compare intended vs. final allocation, review exceptions, and validate approvals.
• Train Trading, PMs, and Operations on edge cases; update procedures where training reveals gaps.
• Put the control into a recurring evidence rhythm (policy attestation, surveillance outputs, exception logs) so exams become retrieval work, not reconstruction.

Frequently Asked Questions

Do we need a specific SEC rule citation for trade allocation, or is fiduciary duty enough?

Allocation expectations commonly sit under the fiduciary duty framework and Section 206’s anti-fraud provisions. If allocation practices operate as fraud or deceit, the SEC can treat them as a Section 206 issue. (15 U.S.C. 80b-6; Release No. IA-5248)

What is the minimum a CCO needs to operationalize this quickly?

A written allocation procedure, an exception/override approval workflow, and evidence showing allocations are consistent with the procedure. Add surveillance that reviews outcomes and documents conclusions. (15 U.S.C. 80b-6)

We can’t always pre-allocate because of speed. Is that automatically a problem?

Not automatically, but it is a high-risk area because it increases discretion after seeing executions. Define when pre-allocation is impracticable and require documentation and review for those trades. (15 U.S.C. 80b-6)

How do we handle partial fills fairly across accounts of different sizes?

Pick a consistent rule (for example, pro rata by intended size with a documented rounding approach) and apply it uniformly. Then test outcomes to confirm smaller accounts are not consistently disadvantaged. (Release No. IA-5248)

What evidence will an examiner actually ask for?

Expect requests for the allocation policy, OMS audit trails showing intended and final allocations, exception approvals, and supervisory reviews that show you looked for allocation harm and resolved findings. (15 U.S.C. 80b-6)

Where does Daydream help without turning this into a documentation project?

Daydream is most useful for keeping allocation controls audit-ready: evidence requests, review sign-offs, exception logs, and policy version history in one place. That reduces scramble risk when exams ask for “show me” artifacts. (15 U.S.C. 80b-6)