Proposed SEC Soft Dollar Rule: Is It What It Appears?
At the Association of Investment Management Sales Executives ("AIMSE") annual conference in Palm Springs in May, a great deal of concern was expressed regarding the impact of the Securities and Exchange Commission's proposed new rule that would require investment advisors to provide clients with an annual report regarding their use of client brokerage. This proposed report would include disclosure about an advisor's use of its clients' brokerage commissions, including information about research and other services purchased by the advisor on a "soft dollar" basis.
The concern expressed at the AIMSE conference was that this SEC proposal, once enacted, would effectively eliminate the practice of soft dollaring and, as a result, significantly reduce the future profitability of investment advisory firms. A close examination of what the proposed new rule actually would require, reveals that these fears are unfounded.
While many people think of this proposal as a "soft dollar" rule, it really isn't. The SEC has stated that the rule is intended to provide investment advisory clients with important information about the brokerage commissions they pay including, but not limited to, their advisors receipt of "soft dollar" benefits. So the proposal really is intended to provide clients with an overall picture of how the advisor directs brokerage. Disclosure is not by any means limited to soft dollaring. For example, included in the report is disclosure of the percentage of commissions directed by clients. This would include brokerage directed for commission recapture, local broker or minority brokerage programs.
Here is a summary of what the proposal would require an advisor to disclose annually:
1) the top twenty brokers to which it directed the largest amount of commissions, 2) the top three "execution-only brokers' to which it directed the largest amount of commissions, 3) the aggregate amount of commissions directed by the advisor to each broker listed, and the percentage of the advisor's total discretionary brokerage this amount represents, 4) the average commission rate (in cents per share) paid to each broker listed, 5) for each broker other than an execution-only broker, a description of the proprietary or independent third party products or services obtained from the broker, 6) the percentages of the advisor's total brokerage that are directed a.) by the advisor to research brokers, b.) by the advisor to execution-only brokers, and c.) pursuant to client specific instructions.
Furthermore, the SEC's proposal does not focus disclosure entirely on third party research services. Instead, the Commission's proposal requires that both proprietary, or internal research, provided by trading firms and third party independent research be disclosed. The SEC was very mindful of the competing interests of proprietary research and third party research providers and specifically chose not to adopt an approach that might be, in the words of the SEC, "unfair to soft dollar brokers."
Clearly, the SEC's new proposed rule regarding an advisor's use of client brokerage will not, if adopted, have any meaningful impact upon money managers' ability to use commissions to purchase research products and services on a soft dollar basis. The SEC has not engaged in any fundamental questioning of the appropriateness of soft dollar arrangements, their effects on the securities markets or the proper interpretation of the scope of provisions of the securities laws that govern these arrangements. Finally, the additional information regarding brokerage required by the proposal is already available to clients who ask and, as a result, is already in the hands of most institutional clients.
Setting Standards For The Investment Management Industry
