Too hot? Too cold? Or just right? For those concerned with the latest Securities and Exchange Commission recipe for soft dollar disclosure, the answer is “all of the above.” Some say the regulator’s proposed reforms go too far. Others say they don’t go far enough. Still others maintain that the regulator’s proposal is right on target.
The latest round in the long-running soft dollar tussle between the SEC and the industry comes as part of the commission’s campaign to revamp Form ADV, the annual disclosure document filed by investment advisers.
Included in the second section of the document is space for money managers to address their usage of client assets to pay commissions to their brokers. The SEC proposed changes to this section and 18 others in an attempt to make Form ADV more user-friendly.
The language proposed for the soft dollar section is not too dissimilar from the existing language. There are some deviations, though, meant to emphasize the conflicts of interest inherent in soft dollar usage. Still, the SEC did not go as far as it could have, and many of the changes were actually proposed before, in 2000.
Importantly, the SEC shied away from requiring money managers to unbundle, or break out, their commission payments into their trading and research components, which is something the U.K.’s Financial Services Authority did when it revised its “soft commissions” policy in 2006.
The comment period for the SEC’s proposal ended in May and produced a slew of reactions. Despite the relatively innocuous changes proposed, many industry players still found fault with them.
“We are deeply concerned that the negative connotations of some of the disclosure that Item 12 would require could lead a client to conclude that soft dollar arrangements are harmful, and therefore, adverse to the client’s interests,” the Investment Company Institute said in a letter to the SEC. The ICI represents money managers at whom the SEC’s proposal is directed.
The Investment Adviser Association, which represents 500 money managers, handling $9 trillion in assets, seconded the ICI, saying the proposed disclosure created a “negative impression” of soft dollar arrangements.
Criticism of the proposal focused on a handful of specific disclosures investment advisers must make. For example, detractors found fault with language that implied advisers were using client dollars to acquire research to avoid paying for it themselves.
The Securities Industry & Financial Markets Association said the disclosures “may create the misleading impression that all soft dollar arrangements are motivated by an investment adviser’s desire to limit its research expenses.”
Detractors also zeroed in on language that implied that in sending orders to research-supplying broker-dealers they were failing in their duties to obtain best execution. The Alliance in Support of Independent Research protested the “negative implication” of this language, also calling it “inaccurate.”
“The SEC has repeatedly stated that the value of research and brokerage services is an important part of a best-execution analysis,” the alliance told the commission. “There is no evidence that advisers compromise or disregard execution quality in submitting portfolio transactions to broker-dealers who provide research.”
Detractors also found fault with a requirement that advisers disclose whether or not they allocate soft dollar benefits to client accounts proportionately. In other words, the SEC suggests money managers should inform their clients whether or not specific commission payments benefit them.
In protest, money manager T. Rowe Price told the SEC that Section 28(e) of the Securities and Exchange Act of 1934, the provision that allows money managers to pay more than the lowest execution fee for research, “does not require that research or other services provided by brokers provide direct benefit to clients paying commissions to such brokers.”
Not all the feedback was negative. The Council of Institutional Investors (CII), which represents 130 pension funds handling a combined $3 trillion in assets, registered its approval in a letter to the SEC.
“We are particularly supportive of the proposed soft dollar benefit disclosures,” CII analyst Andrey Kuznetsov told the SEC. CII’s concern, Kuznetsov noted, was over investment advisers directing trades to broker-dealers based on self-interest rather than their clients’ interest.
Backing the CII is the CFA Institute, which believes the SEC proposal doesn’t go far enough. “We strongly support the proposed disclosure relating to soft dollar arrangements,” wrote Kurt Schacht, executive director for the CFA Institute Centre for Financial Market Integrity, and Linda Rittenhouse, senior policy analyst there. They urged the SEC to further require investment advisers to provide a breakdown of spending on research and execution.
The SEC must now decide whether to approve the changes to Form ADV, and in what form. At a recent SIFMA conference, David Blass, assistant director in the SEC’s Division of Investment Management, acknowledged the negative comment letters, but noted that “soft dollars present significant conflicts of interest.”
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