Labor Dept. Retreats on Soft Dollars

A decision by the U.S. Department of Labor to back off from stringent new disclosure rules covering soft dollars has the industry sighing with relief. Sources warn, however, that the final rules, part of a revision of Form 5500, are still confusing and potentially onerous.

“The alternative rule they have established is responsive to our concerns,” Liz Varley, a Securities Industry and Financial Markets Association vice president and director of retirement policy, told Traders Magazine. “There is now an alternative way to describe the soft-dollar impact to plan sponsors without going all the way toward having to calculate some kind of number on a per-plan basis, which would be nearly impossible to do.”

The Investment Company Institute, which like SIFMA criticized the DOL over its initial proposal, also hailed the final rules. ICI called them “a big and welcome step toward greater transparency for retirement plans.”

Labor’s Employee Benefits Security Administration, or EBSA, the regulator of the $4 trillion pension industry, issued final rules in late November beefing up the reporting requirements of its annual Form 5500. The new regulations require plan sponsors to report compensation-both direct and indirect-received by its service providers, including investment managers.

EBSA’s initial proposal, published in July 2006, drew a sharp rebuke from the industry over its aggressive stance on soft dollars. EBSA considers soft dollars, or the amount of a commission payment attributable to research, a form of indirect compensation.

At the time, SIFMA chastised EBSA for drafting rules that, it said, would be nearly impossible to comply with and result in meaningless information. EBSA initially wanted pension plans to report on a broker-by-broker basis the value of all soft dollars paid by their service providers (investment advisers) on their behalf.

Although such unbundling is now required in the U.K., it has not been mandated by the Securities and Exchange Commission. (See accompanying article.) The U.S. brokerage industry has generally maintained that breaking out commission payments into their research and execution components is an impossible task.

Under EBSA’s final revisions to Form 5500, plan sponsors can avoid reporting the dollar amounts of proprietary soft dollars or the formula used to calculate those amounts. That’s as long as they provide certain qualitative disclosures about the soft-dollar arrangements elsewhere.

Plan sponsors need only provide “a description of the eligibility conditions sufficient to allow a plan fiduciary to evaluate them for reasonableness and potential conflicts of interest,” EBSA stated in its final ruling. Sources contend it is unclear what EBSA meant by this phrase, but that it refers to some sort of qualitative appraisal of the soft-dollar arrangement.

It is also unclear, sources say, whether or not plan sponsors can avoid detailed dollars-and-cents reporting of third-party soft dollars. The final rules seem only to let proprietary research off the hook.

“There certainly remains a negative bias against transparently priced third-party services,” BNY ConvergEx director John Meserve noted. “The burden of proof seems to be a little bit higher.”

Because third-party soft dollars are already unbundled, the industry was never overly concerned about their treatment under EBSA’s new rules. Fund managers know how much they are paying for third-party research and have ready access to the data.

Under the revised ruling, fund managers will still have to make certain disclosures about commissions and soft dollars to the pension plans. If they don’t, the plans are required to come up with a value for the research. “The plan would have to identify the research provider and place a value on that research,” said Lee Pickard, a principal with attorneys Pickard & Djinis who specializes in soft dollars. “I don’t know how they are going to do that.”

SIFMA’s Varley says her organization is working with Labor toward some interpretation of points that are unclear. She expects something out in enough time for the industry to alter its systems. The new rules don’t go into effect for a year.


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