Guidance regarding "soft dollars," or the use of brokerage commissions to pay for research and other services, soon will be proposed for mutual fund directors, a Securities and Exchange Commission official said.
The SEC's division of investment management is working on an interpretive release, according to Jennifer McHugh, senior adviser to the director of the division. She spoke Jan. 10 at a Washington conference on broker-dealer regulation that was sponsored by the American Law Institute-American Bar Association of Philadelphia.
"What the staff is preparing is a recommendation to the commission that they propose guidance to fund boards of directors providing them with insight regarding how to execute their oversight responsibility with respect to the placement of fund trades, including trades that involve soft-dollar-type arrangements," Ms. McHugh said.
EARLIER STANDARD
The guidance would follow an interpretive release issued by the SEC in July 2006 that gave guidance on the types of research and brokerage that are permissible under the commission's soft-dollar regulations. That release changed the previous standard, which had required that soft-dollar research used by fund managers be provided by an executing broker.
The earlier standard "sometimes led to a conflict-type situation where a manager may [have been] incentivized to send trades to brokers who were subpar at execution but provided very good research," Ms. McHugh said.
"Those two decisions have now been split as a result of that release. That has had the positive result, we believe, of promoting increased transparency regarding the cost of brokerage, versus the cost of research and services provided," Ms. McHugh said.
Significant technological changes have taken place with respect to fund portfolio trading, she said. Those include electronic trading and dark pools that allow institutional in-vestors the opportunity to execute trades without having their orders displayed on order books.
"With all of these developments, it is probably becoming easier for fund boards to monitor soft-dollar-type arrangements, and we don't want our guidance to unintentionally interfere with what the market is bringing about in terms of positive changes with respect to the trading of fund portfolio securities," Ms. McHugh said.
Regulators are also beginning to crack down harder on brokerage firms to make sure they get adequate documentation to justify soft-dollar payments.
On Jan. 9, the
Financial Industry Regulatory Authority Inc. of Washington fined Houston brokerage firm Sanders Morris Harris Group Inc. $450,000 for inadequate policies and procedures regarding soft-dollar payments.
The firm opened a
hedge fund operation in New York in 2000, according to James Day, director and chief counsel of FINRA's enforcement division. He also spoke at the ALI-ABA conference.
Sanders Morris Harris "did not have adequate policies and procedures to oversee [and] police the operation of that division," Mr. Day said. One of the problems that FINRA found was that in 2004, the broker-dealer received an invoice from a
hedge fund adviser for $325,000 in soft-dollar payments to pay a consultant and to pay for research.
LACK OF DUE DILIGENCE?
"There was no invoice provided from any research provider and no identification of who the consultant was, what he did or why he should be paid. And the broker-dealer did not follow up," Mr. Day said. "If the broker-dealer had done any sort of due diligence, and certainly reasonable due diligence, it would have found that it should not have paid that invoice."
Sanders Morris Harris didn't return a phone call seeking comment.
FINRA "is emphasizing the duty of oversight, at least to the extent of getting adequate documentation," to make sure that soft-dollar payments are for bona fide research and that appropriate disclosures are made, said Richard Phillips, a San Francisco-based partner in Kirkpatrick & Lockhart Preston Gates Ellis LLP, a Pittsburgh-based law firm.
Sara Hansard can be reached at [email protected].
