New York-Buckle your seatbelts. The rumor is that legislation is being drafted to abolish the 28(e) exemption. If true, the probability that the current soft dollar regime will continue, while still likely, just got smaller.
Here’s the rumor. The initial reaction of Congress to Cox’s letter calling for the repeal of the 28(e) exemption was that the issue was not on their agenda. The pushback to Cox was that if he felt so strongly about it, send over some draft legislation. Reportedly, SEC staff is now drafting legislation to be provided to Congressional staff.
The rumor is from informed sources, but it is unconfirmed. If accurate, what are the implications? We would still say that the chances of 28(e) being repealed are low. Legislation would have to get through committee and past both sides of Congress. There are some strong supporters of 28(e) who will be obstacles to passage, notably Senator Chuck Schumer (D, NY), who sits on the Senate Banking committee. However, in the hurly burly of Washington politics, nothing is a given. 28(e) killer legislation does not need to be a separate bill-it can be tacked on to other legislation.
At this point, we don’t think it a repeal of 28(e) is probable, but some form of Congressional activity is now looking more likely. The bigger issue at this point is what happens to 28(e)-related regulation in the meantime. The SEC has not delivered on its promise for guidance on greater commission disclosure, which SEC commissioners publicly promised by the end of 2006. Ironically, Cox cited poor disclosure as one of the reasons to ban soft dollars-even though it’s his job to define the disclosure requirements. Legislation isn’t required for the SEC to do its job on that front. It is simply a matter of making it a priority for the Division of Investment Management, which is tasked with providing the disclosure guidelines. Will Cox’s call to ban 28(e) motivate staff to move this to the top of their inbox? We doubt it.
Another issue that is going begging relates to the evolution of CCAs in the U.S. One big difference between CSAs as developed in the UK and CCAs as implemented in the US is how proprietary research is paid for. In the US, the CCA broker’s proprietary research is kept out of the commission pool, reducing transparency. One reason for this is concern from brokers about losing their exemption from the Investment Advisors Act.
The broker exemption to the Advisors Act is based on two conditions: the activity being incidental to the brokerage business and receiving no special compensation for it. Brokers or dealers “whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor” are exempt. If a broker’s proprietary research flows through a CCA commission pool, it could be construed as “special compensation”, invalidating its exemption. The brokerage community is split 50/50 on this issue-some see it as an issue and some not. However, attempts to get clarification from the SEC have failed, and it is unclear that it will be resolved anytime soon.
The next milestone in this ongoing 28(e) saga will be testimony from SEC Chairman Cox before the House Financial Services Committee, scheduled for June 26th. This will be closely watched for any clues on Congressional disposition to take up the 28(e) cudgel being proffered by the Chairman Cox. Stay tuned.