New York-The U.S. securities industry trade association, Securities Industry and Financial Markets Association (SIFMA), recently sent a comment letter to the UK securities market regulator, the Financial Services Authority (FSA), arguing that connectivity services and order management systems (OMS) should be permitted by the FSA to be paid with soft dollar commissions.
FSA Amendment
The FSA has proposed to amend its rules relating to the use of dealing commissions to pay for other non-dealing services (i.e., soft dollars) to categorize connectivity services and associated software, including OMS, as non-permitted services. The FSA’s current soft dollar regime was first proposed in July 2005 and went into effect in January 2006. The full text of the current FSA regime can be found at http://www.fsa.gov.uk/pubs/policy/ps05_09.pdf.
SIFMA’s Argument
SIFMA asks the FSA to continue to allow the “softing” of OMS and connectivity services. SIFMA argues that the SEC permits connectivity services, such as dedicated lines between the money manager’s OMS and broker-dealers, as well as “trading software used to route orders to market centers, software that provides algorithmic trading strategies and software used to transmit orders to direct market access (DMA) systems.”
What the SIFMA letter does not discuss is the SEC’s nuanced view regarding OMS systems generally. In its July 2006 guidance, the SEC said that “certain functionality provided through OMS may be eligible brokerage or research” under Section 28(e). The SEC accepts trade analytics transmitted through OMS systems, and, more generally, analytics on optimal execution venues and trading strategies.
Impact on FSA
Will the FSA heed SIFMA’s advice? Although SIFMA makes cogent arguments, its case is undercut by jurisdiction. SIFMA’s members have a major UK presence but SIFMA is a U.S. organization. The bigger issue, however, is that the FSA has consistently taken a tougher stance on soft dollars than the SEC. Even before this proposed amendment, the FSA has had a narrower interpretation of what is permissible for softing. For example, the SEC allows certain narrowly targeted publications such as trade publications or technical journals to be softed whereas the FSA does not permit any such publications. Also, the FSA took the lead on commission transparency, which the SEC has yet to deliver eighteen months after the FSA’s regulations. Perhaps FSA feels that it has the “soft dollar” ball, and the SEC should be looking to it, not the other way round.
For the full text of the SIFMA letter, click here.
Comment by Bill George:
It’s interesting SIFMA is so focused on the safe harbor of 28(e) and the FSA softing regulations that it seems to be ignoring that fiduciary investment advisors have investment discretion when paying for services outside the safe harbor of 28(e). I don’t think any judge or jury would hear a lawsuit alleging that an advisor had breached its fiduciary duty by using client commissions to pay for an order management system or the communication lines necessary to assure timely, high quality execution which might accrue to its institutional clients’ direct benefit. Maybe SIFMA would prefer to do away with investment discretion and fiduciary duty entirely, and just have an environment with specific statutory regulations and no investment discretion.
To me its kind of odd when people who profess to be staunch capitalists formulate arguments intended to socialize the investment in their enterprise infrastructure. Maybe mutual funds should be compelled to give their owners all of the equity interest in the firm in proportion to their account investments – that’s what “mutual” used to mean. If this were to happen clients might feel better about the use of their commissions to buy shelf-space & marketing assistance, IPO’s, and consideration for “flipping” them, and late trading arranements.
It reminds me of a quote, I think it was MIT Economics Professor Paul Samuelson who said something to the effect that, ‘After years of studying mutual fund industry I’ve decided the best way to make money from mutual funds is to own one.’