Passing The Buck


New York—Yesterday the SEC issued draft guidance for directors of registered 40 Act funds relating to ‘soft dollar’ practices.  In the ‘sunshine’ meeting in which the commissioners discussed the proposed guidance, it was clear that the SEC itself, exemplified by Chairman Christopher Cox, has some confusion on the subject.  Yet it is asking fund directors, already overburdened with multiple other responsibilities, to take up the mantle.  After failing to come up with any meaningful soft dollar disclosure guidance in its Form ADV proposals, the SEC is now trying to pass the ‘soft dollar’ buck to the fund directors.

Shockingly, Chairman Cox, after three years on the job, still doesn’t understand soft dollars.   He still thinks of soft dollars as extra commissions paid for third party research, and refers to soft dollars as ‘almost a billion dollars.’  Someone should inform the Chairman that, in fact, soft dollars includes payments to broker dealers for proprietary research and totals between $4 and $5 billion in the U.S.

It is also clear that the Chairman’s intent with the new guidance is to strong arm fund directors into banning soft dollars.  His opening remarks illustrated his ongoing hostility to soft dollars, and he repeatedly suggested that directors should ‘rein in’ the use of soft dollars.  He concluded with two ‘examples’ of how directors might respond to the guidance: 1) they might limit the use of soft dollars or 2) they might prohibit soft dollars.

Perhaps if the Chairman understood that over 90% of advisors pay some form of soft dollars for research he would have a more nuanced view of the situation.  Then again, perhaps not.  The issue is somewhat moot since the Chairman will be leaving soon.  However, it does raise the question: if the Chairman of the SEC doesn’t understand soft dollars, how can you expect fund directors to understand it?  This is the problem the SEC has set itself, aggravated by the fact that the SEC has done precious little to improve the overall disclosure of soft dollars.

Fund directors have a lot on their plate.  During yesterday’s open meeting, SEC staff described how fund directors are being given large ‘books’ of trade data, and have little sense of how to interpret it.  The SEC staff repeatedly used the adjectives ‘overwhelmed’ and ‘befuddled’ to describe fund directors on the topic of execution generally and soft dollars specifically.  In theory, the 38 page draft guidance will provide assistance directors in cutting through the confusion.  We’ll give a considered response once we’ve gone through the draft in detail.  However, the risk highlighted by Commissioner Atkins in his questions to SEC staff is that this becomes one more ‘check the box’ item given cursory attention.

Finally, those of you in the alternative research industry (independent research, if you prefer) should pay close attention to this current proposal.  If Chairman Cox had his way, this proposal would be a back door route to banning or limiting soft dollars.  His influence may be limited, but the sentiments die hard.  Comments on the proposed guidance must be received by the SEC by October 1st.  The full document can be viewed at  The webcast of the sunshine meeting can be viewed at    


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  1. Bill George on

    The portion of the webcast that deals with the proposed interpretive guidance, for fund directors, on soft dollar commissions begins at 1 hour and 15 minutes of the webcast. You can drag the “slider” on your computer’s video player to that point if you are only interested in this subject.

  2. Bill George on

    From: Bill George
    Sent: Wednesday, July 30, 2008 1:07 PM
    Subject: Dear Chairman Cox

    Dear Chairman Cox: I’ve copied and pasted an email (below) which I sent this afternoon to several members of the press, several third-party research providers, several third-party broker dealers and some securities lawyers. In the context of soft dollars and today’s Proposed Guidance for institutional investment fund board members, I believe it’s very important that the true size and financial impact of soft dollar brokerage be acknowledged and emphasized. Furthermore, during the July 12, 2006 Sunshine Meeting at which the “Commission Guidance Regarding The Appropriate Use of Client Commissions Under Section 28(e) of the Securities Exchange Act of 1934” was approved and released, it was stated that soft dollars used to purchase third-party services would no longer be treated differently than soft dollars used to purchase proprietary research (and other services) from brokerage firms. And, at that July 12, 2006 Sunshine Meeting several commissioners and staff members mentioned that a “second wing” of interpretive guidance would soon be released to provide guidance to the industry on the disclosure and transparency of brokerage commissions and services in all institutional brokerage arrangements. In July of 2007, U.S. Senator Charles Schumer reminded you that you had agreed to that the second wing of guidance on disclosure and transparency and that “fund boards and trustees were eager to receive such guidance so they could discharge their fiduciary obligations”. The verbal description of the Proposed Guidance which I watched this morning did not seem to provide any guidance on disclosure, transparency or the identification of proprietary services offered in bundled undisclosed brokerage arrangements. It seems to me that absent specific disclosure and identification of such services it’s difficult, if not impossible, for regulators, fund board members or institutional investors to discern if brokerage commissions are being used in compliance with Section 28(e) and or fiduciary propriety. It also should cause one to wonder how soft dollars used to acquire brokerage firms’ proprietary research and services can possibly be treated with equal scrutiny as compared to third-party fully disclosed investment research.

    From: Bill George
    Sent: Wednesday, July 30, 2008 1:11 PM
    To: Recipients, Undisclosed
    Subject: Soft Dollars and Sunshine

    During today’s SEC “Sunshine Meeting” Chairman of the SEC Christopher Cox stated, in his opening comments (prior to the presentation of the Proposed Guidance to fund directors regarding fund advisors’ uses of fund investors brokerage commissions) that the use of soft dollars by institutional investment advisors now totals approximately “one billion dollar per year”.* This is a misstatement.

    Section 28(e) of the Securities Exchange Act of 1934 describes soft dollars as any brokerage commissions paid-up above the fully-negotiated costs of brokerage execution. An analysis of the annual average of all tangible institutional brokerage execution related costs, as compared to the annual brokerage commissions paid by institutional advisors puts the true annual cost of soft dollar brokerage (in recent years) at something over ten billion dollars per year.

    For years investment consulting organizations and investment advisors have been misrepresenting and misreporting the institutional investment advisory industry’s use of soft dollars. They have only reported soft dollars spent for fully-disclosed (transparent) third-party investment research. They make no attempt to account for soft dollar commissions used to purchase brokerage firms’ proprietary research and other proprietary services which are not disclosed or transparent, and which may not qualify for the safe harbor of Section 28(e) and which may even be outside an advisors’ fiduciary authority. Without disclosure it’s impossible to determine if these commissions paid-up above the costs of fully-negotiated brokerage commissions are appropriate, or if they are used as monetary inducements contributing to conflicts of interest which do not accrue to the direct benefit of the advised funds’ investors.

    The archive of this SEC Sunshine Meeting will soon be posted at >

    The section of the meeting at which the above proposed guidance was submitted and discussed begins at around 1 hour 15 minutes (you can drag your media player “slider” to that point in the meeting).

    Best regards,

    Bill George

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