Some Call Soft Dollar Guidance Weak
July 17, 2006
In an effort to leave less to the imagination, members of the Securities and Exchange Commission last week unanimously approved the first set of soft dollar guidelines issued in 20 years. While some championed the guidelines as a boon to the business, others argued they do not go far enough.
First introduced for comment in October, the guidelines call for money managers to limit their research spending only to products that assist in making investment decisions that benefit investors directly.
"Today's interpretive release makes it crystal clear that research is intended to be restricted to advice, analyses and reports that have substantive intellectual or analytic content," said SEC Chairman Christopher Cox. "There is no safe harbor for overhead like carpeting and computer equipment, or lavish expenditures for interior decorators or beachfront villas."
Third-party research would still be protected under the safe harbor clause and therefore can still be paid with commission fees, an issue that caused certain consternation within that industry and that was the subject of many of the 70 comment letters the Commission received. Section 28(e) of the 1934 Securities Exchange Act, the so-called soft-dollar safe harbor, stems from the 1975 deregulation of brokerage commission fees.
The rule was meant to protect investment advisors from being forced to use the least expensive broker/dealer for execution, if another, more expensive, competitor also offered research or other information that would help the advisor better serve investors.
But since then, the research industry has evolved into a big business of its own. During Wednesday's open meeting, Commissioner Roel C. Campos cited a study published by Greenwich Associates, a financial services consulting company in Greenwich, Conn., that showed during the 12-month period ending in February 2006, research spending accounted for about $1 billion in soft dollars, or about 9% of all equity commissions. Although significant, this represents a slight dip from 2002-2004, when soft-dollar spending accounted for between 10% and 12% of commission fees.
That drop, Campos suggested, may be due to increased scrutiny of the industry following the abusive soft dollar spending of a few rogue money managers that grabbed headlines in 2003.
News of managers behaving badly on investors' dimes drew the ire of politicians like Senators Charles E. Schumer (D-N.Y.) and John E. Sununu (R.-N.H.), who joined forces in 2004 to castigate brokerage firms that allowed such abuses and wrote a series of letters imploring the SEC to issue clear guidelines for fund managers to follow.
Neither senators' office responded to requests for comment regarding last week's vote.
Cox blamed abuses, in part, on the 1986 guidelines, the most recent available. In 1976, the SEC prohibited using commissions to pay for items such as computers, software, periodicals and airline tickets. But in 1986, regulators deemed those standards "unduly restrictive in circumstances." The Commission ruled that the "brokerage and research services" in the statute should include anything money managers use to make investment decisions.
"In some ways, it went the other way and opened the door for broad interpretations of the law," Cox said.
Campos hopes the new guidelines slam that door shut and help restore faith in the industry. "The guidance should ensure predictability so that money managers are not being second guessed," Campos said.
The next step, he urged fellow commissioners, is to encourage brokers to issue annual reports clearly listing the research they buy and the cost to investors. "The power of transparency and disclosure can be enormous," he said.
Robin Hodgkins, president and CEO of Cogent Consulting, agrees. "You cannot prove you are not abusing commissions, but you can prove [to investors] you are using commissions to benefit them," said Hodgkins, whose Summit, N.J.-based company provides software programs that helps buy-side firms monitor, account for and track research spending.
"If asset managers can demonstrate to regulators and to their clients that they are using research dollars to procure research and services that are of tangible benefit to one's clients, that will be a huge win for the buy-side firm."
But others argue the new guidelines are insufficient.
"Designating certain things as being allowable is a slippery slope," said Commissioner Paul S. Atkins. "Regardless of the specificity, there will be those who push it to the limit, and those who, believing they won't get caught, will push it over the limit," Atkins said, adding that he urged fund boards to be vigilant about all research spending.
Cox and Campos both said that the guidelines are not exhaustive lists, but a basic outline.
"All of us will benefit if commission practices are governed by a cleaner, consistent and workable set of principles rather than hazy outlines that must be filled in by enforcement," Atkins said.
And that's why the Consumer Federation of America believes that soft-dollar safe harbors should be eliminated completely, a development that would require Congress to act.
"The new guidelines still allow a more expansive interpretation of what's allowed than when the law was passed in 1975," said Barbara Roper, director of investor protection for the Washington watchdog group. "I think they've made that transition, and I think we're ready to allow market forces to work," she said.
Mandating the industry-wide unbundling of fees does not seem imminent, Roper and others said. However, the new guidelines are a much-needed end to a 20-year spell of SEC silence, Campos commented.
"In the interest of recognizing the realities of the marketplace, this new guidance expands the scope of the provided by' language and preserves the congressional intent, but also moves us into 2006," he said.
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