A Small Step For Commission Disclosure


New York – The new disclosure requirements for pension funds being implemented by the US Department of Labor (DOL) increase the level of commission disclosure for US asset managers.  However, the methods of disclosure allowed by the DOL may undercut the effectiveness of the new guidelines.

The DOL guidelines go a step beyond the SEC, which as we have noted before, has repeatedly deferred any guidance on commission disclosure.  However, the DOL became uncomfortable in its position of leadership, and has watered down the guidelines since the original proposal in 2006.  The net effect is to require greater disclosure, but far less than the disclosure regime implemented in the UK by the Financial Services Authority (FSA) under CP 176, and now replicated in other European domiciles, including France and Germany.  The table below outlines the respective disclosure requirements:

Disclosure Item FSA Guidelines DOL Guidelines Form ADV, Part II (SEC)
Use of commissions to pay for proprietary research Yes Yes In theory
All counterparties paid commissions Yes Yes No
Commissions paid for research by counterparty Yes May substitute formulas or other language No
Commissions paid for execution by counterparty Yes No No
Total commissions paid by counterparty Yes No No
Overall commission rates paid by asset manager Yes No No

The DOL, like the SEC in 2006, has made it clear that commissions paid for proprietary research are soft dollars, and need to be disclosed.  It also requires that all commission counterparties be disclosed.  Unfortunately, after that the DOL’s guidance begins to get murky.  The DOL offers a few options on how to disclose the amount of commissions paid for research, which is of course the heart of matter:

  1. Like the Financial Services Authority (FSA) guidelines under CP 176, the asset manager can provide estimates of the amounts of commissions paid for research by counterparty.  This can be calculated by deducting execution only commission rates or CSA rates from the bundled commission rates paid for proprietary research.
  2. Alternatively, asset managers can provide a formula that plan sponsors can use to derive the portion of commissions used for research.  Examples might be 1.5 to 1 for step-outs (traditional soft dollars) or 2 cents out of every 4 cents for bundled proprietary research.
  3. If the asset manager determines an estimate or formula is not practical, a description of ‘eligibility conditions’ could be provided.  These might be the minimum trading levels required for research services.  For example, an asset manager might commit to a minimum of $1 million in commission trading in order to continue to receive a certain level of research services from a proprietary research provider.

Refer to Pickard and Djinis LLP’s paper on the topic for more details at http://www.alliance-research.org/PDFs/Memo-ScheduleC-Form5500.pdf.

The DOL’s FAQs interpreting the new regulation provide additional caveats.  Pooled investment vehicles such as mutual funds and hedge funds are exempted from the disclosure requirements.  The form of disclosure is also problematic.  Commission information does not need to be included in the DOL form (Form 5500) if it is separately disclosed by the asset manager to the pension fund.  The DOL does not provide any guidance on whether the separate disclosure should be one document, multiple documents, or multiple documents from multiple sources.

On the one hand, the DOL has clearly stated that commissions paid for proprietary research and third party research are a form of compensation to the asset manager and need to be scrutinized by pension funds.  However, it is not clear that the level of disclosure mandated by the DOL will make it easy for pension funds to understand and interpret commissions paid for proprietary research in particular.  The risk is that scrutiny will continue to fall solely on third party research.

We received a call last week from someone trying to track down the source of a ‘guideline’ being spread around asset managers that third party research should be capped for pension fund accounts at 25% of total commission spending.  Unfortunately, this is an example of the type of disinformation prevalent in the pension community today.  Possibly the new DOL guidelines will help, but we will believe it when we see it.


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