SEC Examines Proprietary Soft Dollars


New York—Mutual funds are squawking about new examinations detail being requested by examiners from the SEC’s New York office, especially information requested relating to the potential misuse of non-public information.  Not specifically cited by irate funds, but nevertheless of interest to our readers, the new exam letters request information on proprietary soft dollar commissions—i.e., bundled commissions used to pay for broker/dealer research.  This is an important step in the leveling of proprietary research and third party research. 

Examinations have never been a fun process for investment advisors, frequently lasting weeks with SEC examination staff camped in investor’s offices poring over documents.  We obtained a copy of a recent examination letter dated August, which was sent to an investment advisor prior to the exam detailing the information requested for the exam.  We can understand why investment advisors are upset—and why most hedge funds will never willingly register with the SEC.  The exam letter is 27 pages, mostly detailing reams of information required by examiners. 

The items receiving the most attention are information relating to the potential misuse of non-public information, which require extensive information about PIPEs transactions.  Our attention was drawn to the soft dollar section, which requires detail on both third party and proprietary soft dollar arrangements.  

At the moment, soft dollars are mainly associated with third party research (aka, independent or alternative research).  Although the 28(e) was originally legislated to preserve proprietary broker/dealer research as fixed commissions were abolished in 1975, bundled commissions helped everyone forget this fact.  Instead, the cumbersome arrangements used to direct commissions to pay for third party research became synonymous with soft dollars and the exam process helped to reinforce this misperception. 

According to Theodore Eichenlaub of Adviser Compliance Associates, which assists institutions on regulatory compliance, examiners focused primarily on third party soft dollars because there was more information available—soft dollar ratios, contracts and so on.  Things started to change with the SEC’s guidance on soft dollars in July 2006, which reiterated that proprietary research paid for by bundled commissions is in fact soft dollars.  And now, examiners are beginning to refocus on this fact during the exam process.

Soft dollar related items requested by the SEC are listed below.  The information is still skewed toward third party soft dollars, since there is more information to disclose.  However, the exam letter asks for a listing of all proprietary soft dollar arrangements.  As more large investment banks require minimums to maintain research service levels, these arrangements will need to be disclosed.  CCA’s will also be included.

The exam letter also requests detail on independent research providers, including contract terms, fees, seminars attended, and issuers covered.  It is unclear why independent research providers are singled out for SEC scrutiny during the exam process.  Or, said another way, it is odd that the SEC is not focusing on the seminars, management access, capital commitment and other services included in full service commissions.  The current exams are a step in the right direction but are still subject third party research to more scrutiny than proprietary research.

The full letter can be found at

C. Soft-dollar Arrangements

 1. Provide a list of the soft-dollar arrangements, both third-party and proprietary, to which Adviser(s) were a party during the Examination Period. This list should be provided in Excel format and should include the following information for each arrangement:

a. The name of the broker or other entity involved in each arrangement;

b. The nature of the goods or services received by Adviser(s) under the arrangement;

c. Whether the goods or services are third-party or proprietary or both;

d. A detailed description of how the product or service is used by Adviser(s);

e. The approximate annual amount of commissions on securities transactions needed to

satisfy each arrangement;

f. The soft-dollar ratio with respect to each arrangement;

g. Whether the product or service received is within the Section 28(e) safe harbor;

h. The allocation procedures used if this item is considered to be mixed use;

i. The hard-dollar cost of each product or service for the current year to date and the

previous year;

j. The total brokerage commissions used to obtain each product or service for the current year to date and the previous year;

k. The types of transactions used to generate soft dollars for this agreement (i.e. equity or fixed income, listed or OTC, agency or principal, or new issue designations);

l. The current amount of soft dollar credits generated by securities transactions placed

by the adviser for the current year to date and the previous year;

m. Whether or not invoices or statement which record soft and/or hard dollars paid are

sent to Adviser and, if so, how often; and

n. Whether the broker-dealer providing the product or service is contractually obligated

to pay the cost of the product or service.

M. Independent Research Providers

1. Provide a list of all independent research providers, if applicable, utilized by the Adviser during the Examination Period. For all such service providers, provide the corresponding contract/terms of use, fee schedule, and proof of payments.

2. A list of any seminars, conferences, or other programs attended by the Adviser’s employees, officers, or agents that were conducted, offered or paid for, directly or indirectly, by research providers or broker-dealers during the Examination Period.

3. A list of the issuers that the research provider provided research on; the format in which the research was delivered, and the date the research was provided; and, whether the research provider and its affiliates are investors in pooled investment vehicles managed by the Adviser and/or its affiliates.


About Author

Leave A Reply