Regulators Cloud Commission Transparency


New York – New disclosure requirements for pension funds being implemented in July, 2010 will increase disclosure of the commission (‘soft dollar’) arrangements for both proprietary investment banking research and third party alternative research.  However, we believe there will be greater scrutiny of commissions paid to third party alternative research providers because of lower standards of disclosure required for bundled proprietary research.

Despite the good intentions of the Department of Labor (DOL), we are skeptical that the new guidelines will improve understanding of soft dollar commission, or add any transparency to an extremely opaque topic.  We have seen the pension community pressuring asset managers to reduce their use of alternative third party research because of a flawed understanding of ‘soft dollars’ and we doubt the DOL regulations will fix this.   The net effect of the pension community has been to decrease transparency in research pricing, as more alternative providers choose to bundle their research with commissions.  The culprit here is not the DOL, however, but the SEC which has repeatedly missed its stated targets for improved soft dollar disclosure.


As we reported at the end of 2007, the Department of Labor Employee Benefits Security Administration (EBSA), the regulator of ERISA plans, now requires increased disclosure starting in July, 2010 of ‘soft dollar’ commission payments along with other indirect compensation received by asset managers managing pension assets.   However, after lobbying by investment managers and the brokerage industry, the EBSA narrowed its disclosure requirements for soft dollars, greatly reducing the level of disclosure for proprietary research.

As the result of intense lobbying, EBSA also provided an “alternative reporting option”, which most, if not all, pension funds will follow for the soft dollar reporting requirements.  The alternative reporting option allows pension funds to rely on Form ADV disclosure and any disclosures in the investment management contract.  The information required is 1) whether the investment manager is receiving soft dollars, 2) the reason for receiving soft dollars, 3) the amount of soft dollars or the formula used to determine soft dollars, and 4) the payer of the soft dollars.

It is possible that the new DOL regulations could improve the level of disclosure which investment managers provide to pension fund clients.  At the very least, asset managers might make sure their Form ADV reporting is correct—and clarify that bundled commissions paid for proprietary research is in fact a form of soft dollars.  Although the amounts paid for proprietary research will not be disclosed, the fact that they are being paid for proprietary research will be a revelation for most plan sponsors (and sadly, some fund trustees.)  However, given the amount of disinformation among pension consultants and plan sponsors, we are not optimistic that the confusion over soft dollars will be helped by the DOL requirements.

Proprietary Research

Under pressure from lobbyists, the DOL decided that detailed disclosure of proprietary research “may not be practical”:

“The Department recognizes that it may not be practicable to provide a formula or estimate to calculate the value of certain types of ’soft dollars’ non-monetary compensation at the plan level, particularly so-called ‘proprietary’ soft dollar arrangements, such as access to information from certain research specialists. In such circumstances, a description of the eligibility conditions sufficient to allow a plan fiduciary to evaluate them for reasonableness and potential conflicts of interests would satisfy the ‘amount of compensation’ prong of the disclosure alternative for Schedule C reporting.”

Ironically, it is now very practical for investment managers to report a formula for unbundling proprietary research from commissions, thanks to the widespread adoption of commission sharing arrangements (CSAs).  As we have reported elsewhere, with the post-crisis decline in commissions, asset managers are using electronic trading and CSAs to reduce the volume of bundled commission payments as a way of stretching commission dollars further.  As a consequence, most asset managers are quite able to provide a formula for estimating the portion of bundled commissions which are attributable to research.

SEC Inaction

The primary argument used by lobbyists arguing to exempt proprietary research from the DOL disclosure was that the SEC would be providing guidance on soft dollar disclosure in the near future.  This was in 2006.  The mutual fund trade group, the Investment Company Institute (ICI), asked that the DOL defer to the SEC on soft dollar disclosure, arguing that the SEC guidance on soft dollars was imminent: “SEC staff have stated publicly that they expect to present recommendations to the Commission by the end of the year [end of 2006].”

The securities industry trade group, SIFMA, told the DOL that the “close scrutiny being given to soft dollar arrangements by the SEC is sufficient to ensure that any potential abuses in this area are being addressed” and therefore oversight by plan sponsors is unnecessary.

The SEC’s efforts on soft dollar disclosure have been feeble at best.  After releasing guidance on soft dollars in July 2006, SEC commissioners promised guidance on soft dollar disclosure by year end 2006.  Nada.  In March, 2008, The SEC implemented some changes to Form ADV which focused on third party soft dollars rather than proprietary research.   In July, 2008, the SEC proposed guidance to mutual fund trustees which was never adopted.  We are told that SEC inspectors are paying more attention to bundled research, but, overall, the SEC has done an abysmal job on soft dollar disclosure.


The big issue for third party research is that the playing field continues to be unlevel.  Third party soft dollars have not gotten a pass on detailed disclosure, as proprietary research has.  Under the DOL regime, investment managers are exempted from disclosing the plan level detail on bundled proprietary research, something that is relatively easily disclosed for third party research.    As we have already seen, this is a significant disincentive for investment managers to use alternative research.

This is an issue which will need to be tackled by alternative research industry leaders and by its trade association, Investorside.  The SEC is a natural point of focus, but so are pension consultants and mutual fund directors, which need improved information on the topic of soft dollars.

In the meantime, more and more alternative research firms are looking at options to ‘bundle’ their research with commissions by adding trading desks, or by working with distribution partners which can offer access to trading desks.  Unfortunately, to win some buy side clients, this is a must.


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  1. Bill George on

    This is a very good article.

    However, I believe it should be more clearly stated that Commission Sharing Arrangements (CCA’s) and their equivalent, for which the SEC has handily provided the ‘semantic-fog’ definition of Client Commission Arrangements (CCA’s) do nothing to provide any greater transparency of soft dollar commissions in bundled undisclosed soft dollar brokerage arrangements.

    CCA’s merely allow a full-service executing broker to distibute soft dollar commissions to third-party research providers. There is still a pool of commissions controlled by the executing broker which that broker uses to compensate itself for research and ‘other services’. And, because that pool of commission dollars remains bundled and undisclosed that pool of brokerage execution commissions and soft dollar brokerage commissions is not subjected to any transparency or accounting.

    Soft dollar commissions paid to full-service brokers in bundled non-transparent brokerage commission arrangements have been conservatively estimated to 85% of all soft dollar payments. Soft dollar commissions paid to third-party (independent research) providers in compliance with Section 28(e) of the Securities Exchange Act of 1934 are less than 15% of soft dollar commissions. These third party arrangements, by their very nature, are fully disclosed.

  2. Bill George on

    The abbreviation in the first line of second paragraph above should be CSA’s. – Bill George

  3. Bill George on

    Absent a regulatory mandate for soft dollars transparency in bundled undisclosed soft dollar brokerage arrangements, it seems soft dollars could be made transparent using transaction cost analysis (TCA)?

    It could be done through a somewhat algebraic approach where the explicit costs of brokerage execution are separated from the implicit costs (market impact). Then the explicit execution only part of transaction cost would be subtracted from the brokerage commission charges paid. The difference between the TCA discovered explicit costs of execution and brokerage commissions paid is the amount of brokerage commission ‘paid-up’ by the advisor, and therefore fits the definition of soft dollars as outlined in Section 28(e).

    Such an analysis would identify soft dollar brokerage commissions used and it would allow the trustees of pension plans, mutual fund boards of directors, and corporate plan sponsors to monitor soft dollar expenditures by advisors’, portfolio managers’ and traders’. It would also provide a basis for evaluating the proper uses of those soft dollar brokerage commissions [under Section 28(e)] and, over-time it would allow measurement of the costs and the benefits of soft dollar brokerage commissions exchanged for research.

    This is a “back door approach” to discovering soft dollars in bundled undisclosed institunal brokergage arrangements, but absent a regulatory mandate for soft dollar transparency in all institutional brokerage arrangements it seems a viable, yet somewhat costly, approach.

    Some institution advisory entities already do transaction cost analysis to monitor “best execution” and as an internal management tool. For those entities this approach to soft dollar transparency could be accomplished with little additional expense.

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