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September 28, 2006

SEC Says Never Mind' on CSAs

By Gregory Bresiger

Small, introducing brokers can continue their commission sharing arrangements (CSAs), according to the Securities and Exchange Commission's interpretative release on soft dollars.

The SEC, which issued the release in late July, is in the process of re-examining Section 28(e). This rule allows alternative commission arrangements, but the SEC had wanted to impose stiff new requirements on mom-and-pop introducing brokers that work with bigger brokerages.

"The SEC did a 180-degree flip," said William Edick, an attorney with the Washington-based Alliance in Support of Independent Research. His group helped argued that introducing brokers using CSAs are critically important for managers needing independent research and for obtaining best executions.

These small brokers often provide research to money managers through CSAs. Previously, the SEC had taken the position that the introducing broker had to be directly involved in "effecting" the trades that pay for the research and had to meet four requirements for the effecting test.

That triggered complaints from trading officials, who warned that new regulations could end CSAs, putting some small shops out of business and making it harder for money managers to find independent research.

The SEC initially moved last year to tighten Section 28(e) rules covering CSAs because it viewed them as dangerously close to give-ups. But recently the SEC reversed itself, easing the requirements for the introducing broker. Regulators now believe CSAs should be allowed for an introducing broker "effecting transactions if it performs only one of the four identified functions and takes steps to see that the other functions are reasonably allocated to one or another of the broker-dealers in the arrangements," according to the SEC release. The functions are: 1)Taking financial responsibility for all customer trades until the clearing broker-dealer has received payment or delivery of the securities; 2)Making or maintaining records related to customer trades required by the SEC or SRO rules, including blotters and memoranda of orders; 3) Monitoring or responding to customer comments concerning the trading process; 4) Generally monitoring trades and settlements.

Previously, the broker had to do all four.

The SEC interpretative release, which covered which commission arrangements are allowed and not allowed under the latest interpretation of Section 28(e), was the subject of much lobbying by OMS vendors and brokers. Although CSAs and soft dollar-supporters are happy, they say that the CSA battle is not over. That's because, they note, Section 28(e) itself never changed. But, the interpretation of Section 28(e) has changed.

And SEC officials have said they invite more comments and that they might offer "supplemental guidance" on commission arrangements. Said one lawyer involved in CSAs:"Section 28(e) has been reinterpreted at least three times since its inception. In 1976, 1986 and in this latest interpretation. They could always come back again with another interpretation on CSAs."