New York—The SEC is starting to receive comments on its proposed changes to Form ADV, and, fittingly, the first few comments pertain to the soft dollar disclosure provisions. The first comment was filed by David Riedel, President of Riedel Research, a leading alternative provider of emerging markets research. Riedel’s comment focuses on the disparity of disclosure between soft dollar payments to third party research and bundled commissions for proprietary research offered by large investment banks.
Riedel’s comment argues that the SEC should be requiring disclosure of all commission payments above the cost of execution, not just payments to third parties. The comment highlights the grey area of the proposed amendments to Form ADV—the SEC is requiring more narrative disclosure relating to ‘bundled’ commissions but stopped short of requiring the disclosure of amounts paid.
Riedel refers to payments for third party research as soft dollars, whereas the SEC appears to be treating both third party research payments and ‘bundled’ payments for proprietary investment banking research as soft dollars, since both entail the payment for research with commissions. However, where Riedel’s comments are on the mark is that the SEC has not shown the appetite to require the same level of disclosure for ‘bundled’ payments as is current market practice for third party research.
In fairness, the SEC has been supportive of the spread of client commission agreements (CCAs, also known as commission sharing arrangements, CSAs, outside the US), which allow investors to consolidate trading with a fewer set of counterparties and pay for research separately. CCAs are creating more transparency by ‘unbundling’ research commissions from trading commissions. However, in the US, the large investment banks have largely refused to unbundle their own research, whereas, in Europe, they have done so. The SEC does not appear to be taking steps to rectify this.
The second comment on Form ADV is from Bill George, who is well known to regular readers of this blog as a passionate advocate of greater commission transparency. George’s comment focuses on the SEC’s omission of the requirement for advisors to disclose whether they negotiate commission rates, questioning how this could be burdensome when markets have been in a negotiated commission environment since fixed commissions were abolished in 1975.
Comments, along with the proposed rule (Release IA-2711, Mar. 3, 2008, Amendments to Form ADV) can be viewed with the following url: http://www.sec.gov/rules/proposed.shtml. The deadline for filing comments is May 16, 2008. Riedel’s comment is included below:
Subject: File No. S7-10-00
From: David Riedel
Affiliation: President, Riedel Research
March 5, 2008
To whom it may concern:
I would like to weigh in on your proposed changes to the Form ADV and in particular to the enhanced disclosure within Item 12 with regard to Brokerage Practices in general and use of soft dollars in particular.
I believe that your stated aim to require a full disclosure of arrangements that we believe involve significant conflicts of interest. would be best served by disclosure of all payments of commission above the cost of execution rather than just those paid through a soft dollar arrangement to a third party. You are quite right that the use of client securities transactions to obtain research and other benefits creates incentives that can result in conflicts of interest between advisers and their clients – these conflicts are just as possible when the benefits are provided by a single firm as when provided by two separate firms.
The bundling together of execution and research by a single firm creates the same conflicts of interest that you are concerned about with regard to soft dollars. In both cases the client is being asked to absorb higher transaction fees to pay for a service that the adviser considers valuable.
It is clear that the disclosure should ask whether the adviser uses client securities transactions to obtain benefits other than transaction execution. If the answer is Yes then the full range of conflicts it has when it accepts these benefits and should be described and how it addresses those conflicts should be disclosed.
When the item asks whether the adviser pays up for benefits, this should not just be limited to soft dollar benefits but rather to any situation where the adviser pays more than the lowest available cost in the market for the execution of that transaction.
The comment in footnote 98 makes this point very clearly. This note outlines the requirement that advisers to disclose whether clients pay commissions higher than those obtainable from other brokers in return for products and services. This is precisely the point of my comment. Advisers should be required to state whether they pay commissions higher than the lowest obtainable in the market and justify any such arrangements. Not just soft dollar arrangements but any arrangement that bundles execution with research or any other product (or) service.
Only by including all types of commission arrangements that combine execution with other products and services will you accomplish your goal of full disclosure of arrangements that involve significant conflicts of interest.
Please do not hesitate to contact me to discuss this in more detail.