Notes From a Conversation with Those in the Know


New York – In conversations with a number of regulatory experts, we have compiled a brief synopsis of the key talking points for our readers.

Soft Dollar Misunderstandings

According to July’s interpretive guidance on the use of client commissions, soft dollars continues to be defined by the SEC as everything in the commission payment which is in excess of the cost of execution.

The onus has always been incumbent on the money manager and its fiduciary responsibilities to its clients to determine that the commission dollars were being appropriately spent.  Even so, the money manager has traditionally been reliant on their brokers to maintain records about the amount of commissions generated and how they were spent.

According to sources, many money management firms continue to state in their Form ADVs that they use little to no soft dollars as part of their business. Clearly, they do not understand the definition of soft dollars. We repeat: The SEC defines soft dollars as all commission payments which are over and above the pure cost of execution. Unless you are operating with an execution only broker and you have no access to research, you are engaged in soft dollar transactions.

According to our sources, the SEC is likely to address these misreporting (or is it a misunderstanding) issues in the near term, in an effort to improve the level of reporting and understanding in this area.

Publishers’ Protection or Investment Advice

Another area of great concern to the street is the somewhat arbitrary distinction between research and advice. The latter would suggest that the broker ought to be a registered, which would bring with it a more stringent set of rules and regulations.

Brokers are currently grappling with how much “advice” they can offer without crossing the line into the RIA space. Many alternative research companies stand squarely behind the “publishers’ exemption”.  However, these research companies could be assessed as being at least in the grey-area between “the freedom of the press” and necessitating the fiduciary requirements of providing investment advice.

Wither the Commission Allocation Rules

Another topic of interest is where the Division of Investment Management is on setting rules for disclosing commission use to clients.  Some of our sources suggest such a proposal is “immanent” – but like overvalued stocks – this is likely to remain “immanent” for some time. Additionally, the deliverable keeps changing shape, from rules to guidance.

Left alone, the Department of Investment Management can be expected to take its time with any clarification on the process of allocating commission spend.  However, there is another, potentially more dangerous, oar in the water. The Department of Labor has uncharacteristically inserted itself into the mix. This may force a prompter response from the SEC designed to avoid more onerous regulations.

Comment by An Involved Person:
The following was printed in Compliance Reporter Daily:

Counsels Continue To See Decline In Side Pocket, Soft Dollar Use
In-house counsels at investment management firms said they are continuing to see a decline in the use of side pockets, side letters and soft dollars. The Securities and Exchange Commission has been reviewing side letter and side pocket use at hedge fund advisers, while soft dollar use has been steadily declining. “When we have the option to opt out of side pockets, we do,” Ashleigh Swayze, chief operating and compliance officer and general counsel at Gleacher Fund Advisors in Greenwich, Conn., told a conference in New York sponsored by Institutional Investor Events. “These days the use of side letters has decreased.” Swayze added that some hedge funds are not using them at all. Side letter arrangements give certain hedge fund investors preferential terms in relation to fees, redemption rights and transparency. Bernard Adams, general counsel and CCO at ARX Investment Management in New York, told the conference that the problem with side letters is that they are hard to track. Generally, the firm will not use them unless the letters involve everyone in a fund, Adams said. These letters differ from side pockets, which concern illiquid assets regulators fear hedge funds could be concealing (CR, 11/6).

With the regulatory scrutiny, many things firms would have done before, such as side pockets, they avoid now, added Christy Stagemeyer, assistant general counsel in the Alternative Investment Group at Bank of America. In addition to the SEC, regulators including the Hong Kong Securities and Futures Commission and the International Organization of Securities Commissions have been looking into side letter use (CR, 1/29). Swayze said that more than half of the fund managers associated with the firm do not use the Section 28(e) soft dollar safe harbor at all. Adams noted soft dollars may still be critical to firms starting out because they may not have a lot of money.

Shouldn’t the individuals quoted be informed of what the reality of 28(e) is? May be Institutional Investor Events needs to be contacted too.


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