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April 3, 2008

SEC Expands Soft Dollar Disclosure

By Peter Chapman

The Securities and Exchange Commission's new soft dollar disclosure rules, part of a proposed revision of Form ADV, will have an impact on relations between investment advisers and their customers, the experts agree. How difficult it will be for money managers to comply with the proposed changes is not as clear.

"This is a significant step forward since at least 1999, when the SEC's Office of Compliance Inspections and Examinations came out with a soft dollar report that dealt with disclosure," said Kevin Zambrowicz, a partner with attorneys Bingham McCutchen in Washington, D.C. "This is a first attempt to try to create some rationality and some greater granularity. It will clearly have an impact on a number of firms."

Others contend the rules as proposed will lead to fruitful conversations between advisers and fiduciaries and won't require much more work. "Complying will not be difficult or burdensome for money managers," said Kelly Abernathy, general counsel at agency brokerage CAPIS. "The method is different, but the information is primarily the same."

Abernathy adds that the proposal is a win for users of soft dollars, as it confirms their legitimacy and will result in better-informed investors. CAPIS sponsored a study last year by Greenwich Research that showed money managers wanted SEC guidance when it came to soft dollar disclosure.

"The overarching concern of the managers was that they weren't sure they were meeting the SEC's expectations regarding disclosure," Abernathy added. "So, this proposal certainly answers that question."

Soft dollars is just one aspect of an SEC proposal put out for public comment last month to update the reporting requirements of Form ADV. Investment advisers are required to file this two-part form as part of the registration process with the SEC. The first part includes a description of the adviser and is filed electronically. The second part describes the adviser's services, fees and investment strategies. It does not have to be filed electronically, but will have to be if the SEC adopts the proposed rules.

Among the changes proposed for soft dollar disclosure, the commission wants advisers to describe their soft dollar practices in plain language. More specifically, it wants advisers to describe the conflicts of interest they have when they accept soft dollar benefits, as well as how they will address those conflicts.

The SEC also wants advisers to disclose whether or not they "pay up" for soft dollar benefits. Paying up refers to the accepted practice of paying more than the lowest commission rate for research and other services approved under Section 28(e) of the Securities Exchange Act of 1934.

What the proposal does not do is to require money managers to supply their customers with quantitative measures of their use of soft dollars. They do not have to provide their total commissions spend. Nor do they have to identify how much of their clients' commissions is used for research. In other words, no unbundling, as some were expecting.

"Clearly, this doesn't go all the way to unbundling," Abernathy said. "But it will provide investors and fiduciaries with information that will enable them to question their money managers about how much of their commissions are being spent on research versus brokerage."

Still, compliance won't be a cake walk, said Zambrowicz. "They will have to talk about the fact that they are paying up," he said. "They will have to talk about the fact that they are getting something as an adviser that they would've had to pay for themselves if they weren't using soft dollars. That sort of granularity doesn't exist today."

Comments about the SEC proposal are due May 16.

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