Increased Soft Dollar Disclosure with SEC’s Form ADV Revision?


New York, NY – On July 21, 2010, the Securities and Exchange Commission unanimously voted to revise Form ADV — the principal disclosure document that SEC registered investment advisers are required to provide clients and prospective clients.  As part of this revision, the SEC is mandating that investment advisers provide plain English descriptions of the adviser’s business practices, fees, conflicts of interest, and disciplinary information. In addition, the new Form ADV document will provide more transparency about investment advisers’ use of “soft dollars” to obtain research and other non-execution related services.

Form ADV Requirements Regarding Soft Dollars

Many investment advisers receive research services, or other products and services other than execution services, from broker-dealers or other third-parties in connection with client securities transactions.  The revised Form ADV defines these services as “soft dollar benefits”. 

It is particularly noteworthy that the new Form ADV makes a special effort to clarify a general misconception in the marketplace about what are soft dollar benefits.  The form notes that an investment adviser’s disclosure and discussion of soft dollar benefits must include, “in the case of research, both proprietary research (created or developed by the broker-dealer) and research created or developed by a third-party.”  In other words, clients who receive broker-dealer research as part of a bundled execution arrangement are using soft dollars.

As a result of Part 2, item 12 of the revised Form ADV, an adviser that receives soft dollar benefits in connection with client securities transactions is required to disclose its practices and to explain the conflicts of interest that using soft dollars creates.  These conflicts might include the fact that an investment adviser that receives research “for soft dollars” doesn’t have to produce this research themselves.  In addition, some advisers might be motivated to select a broker-dealer in order to receive the research they produce rather than obtaining the most favorable execution for their clients.

As part of this description, the investment adviser must disclose whether it “pays up” for soft dollar benefits — in other words does the adviser pay a higher commission rate than it could obtain from other broker-dealers in return for the products or services it receives. 

In addition investment advisers must explain whether they use soft dollars to benefit all clients accounts, or only for those accounts that pay for these benefits.  As part of this discussion, the investment adviser is expected to explain whether they allocate the benefits to client accounts proportionately to the soft dollar credits those accounts generate.

The revised Form ADV Form also requires that investment advisers describe all of the products and services that it receives in exchange for soft dollars.  This description must be specific enough for investors to understand the types of products or services that the adviser is acquiring and to permit investors to evaluate the associated conflicts of interest.  Disclosure must be more detailed for products or services that do not qualify for the safe harbor in Section 28(e) of the Securities Exchange Act of 1934.

Consequences of this Disclosure

As you might guess, various market participants were unhappy with the new soft dollar disclosure requirements included in the revised Form ADV.  However, it is clear to the team at Integrity Research Associates that the SEC did not mandate the type of specific disclosure of soft dollar payments made to individual brokers or third-party providers as required by the UK’s Financial Services Authority (FSA) under CP 176, and now replicated in other European domiciles, including France and Germany.  In fact, even the US Department of Labor’s Form 5500 requires more extensive soft dollar disclosure than required by Form ADV.

Consequently, we are not convinced that the SEC’s new Form ADV will contribute much to enhance soft dollar transparency in the US.  However, we are pleased that the SEC made it clear in its new Form ADV form that whenever an investment adviser “pays up” for execution services and receives investment research — even if that research comes from broker-dealers — they are using soft dollars.

For the official description of the SEC’s amendments to Form ADV as included in the Federal Register, click here:


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