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News September 4, 2006 Issue

Conferences, Golf, and Other Imponderables: Soft Dollars? Entertainment? Or What?

Mark your calendars! The Society of Petroleum Engineersí technology conference is just a few weeks away. Youíll want to bend over backwards to attend the Spine Arthroplasty Societyís annual meeting in Berlin. And donít forget the CTIA International Wireless Telecom Conference in Vegas, baby.

As has been explicitly recognized by the SEC in its recent soft dollar interpretive release, these types of conferences provide valuable information for portfolio managers, analysts, and other advisory firm personnel. In the release, the SEC confirmed that the cost of attending seminars or conferences may be research eligible to be softed under Section 28(e), provided that the event "truly relate[s] to research" by providing "substantive content" about issuers, industries, and securities. The SEC also reiterated that the cost of travel and related expenses associated with arranging trips to attend such seminars and conferences is not eligible under Section 28(e).

Letís look at this from a CCOís perspective. If one of your firmís portfolio managers is invited by a brokerage firm to attend a "true blue" research conference (as opposed to a fun-in-the-sun boondoggle), the cost of the conference could be softed under Section 28(e). Provided, of course, that the conference provides "lawful and appropriate assistance" in connection with your firmís investment-decision making responsibilities. If the conference focuses on the domestic health care sector, and your shop focuses solely on international equities, your portfolio manager may be out of luck. And, of course, the amount of commissions paid must be reasonable in light of the value of the conference.

The cost of the portfolio managerís plane tickets, hotel accommodations, and meals must be paid out of pocket, i.e., hard dollared.

According to Pickard and Djinis partner Mari-Anne Pisarri, the value of a conference is properly viewed as a soft dollar item, even if it is not formally applied against your firmís soft dollar commitment. "It doesnít really matter," she said. Clearly, she said, an adviser is offered such opportunities because of the brokerage business it has sent to the broker-dealer. "You donít get invited unless youíve done a certain level of business," she said.

So far, the analysis is straightforward.

But say your portfolio manager is sitting there at the conference, diligently learning about spines or plastics or whatever, when he is approached by a brokerage firm representative who invites him to join a group afterward for golf. "Itís on us," says the brokerage firm rep, implying that his firm will pay the golf fees.

At that point, it seems, the question of whether the portfolio manager should accept the invitation will turn on your firmís gifts and entertainment policy. Letís assume the golf fees are not excessive or lavish. Since playing golf is customary business practice, it would seem permissible for the portfolio manager to accept the brokerís invitation, right?

But letís tweak the facts just a bit more. Say the brokerage firm rep tells the portfolio manager that a few industry CEOs will be joining the golfing party and that they would welcome the opportunity to discuss their companies while out on the links. From the portfolio managerís perspective, and the perspective of the advisory firm as a whole, this is good: As the SEC acknowledged in the soft dollar release, direct access to corporate CEOs also can be a form of valuable research. The release made clear that oral research, such as that obtained from talking to corporate executives, is eligible under Section 28(e), under the theory that "reasoning or knowledge" about the company will be conveyed. However, the SEC explicitly stated that travel and related expenses, such as meals and entertainment, associated with arranging trips to meet corporate executives are not eligible under the safe harbor.

Itís about here where things start to get murky. Is the question of whether the portfolio manager can accept the golf-with-CEOs invitation still properly analyzed under the firmís gift and entertainment policy? Or has the issue somehow crossed the line into one of soft dollars?

Itís not just a theoretical question, and itís not always golf. "There are a few different ways it can come up," said one CCO. "White water rafting, tennis, any number of other things. Some of this stuff gets really strange. You donít even know what is going to happen before you get there. You think you are going for the nuts and bolts and then they say, ĎOh, weíre all going out to do this.í"

In another scenario, a portfolio manager may be invited to a meeting, "where the Ďmeetingí is youíre going to play golf with analysts from the brokerage firm and CEOs from various companies," the CCO said. If the invitation was to meet with the analysts and the CEOs in a meeting room, she reasoned, "you wouldnít pay the broker for the meeting room." So, she asked, "do you pay them for the golf?"

The CCO also noted that sometimes, advisers receive gifts during conferences and seminars, such as a polo shirt or jacket with the name of the broker. If you take it, she said, should you pay them for it later?

The CCO raises a good question. To get some answers, IM Insight spoke to a range of investment management legal and compliance experts. Different folks had different views, and no clear consensus answer emerged.

Probably the best way to think about it is as follows: If the portfolio manager were simply invited out for golf with the brokerage firm reps, the question would be whether the golf is acceptable under the firmís gifts and entertainment policy.

However, when the golf includes access to CEOs, that "access" is an additional benefit. To some, the presence of that additional benefit, which is in the nature of a soft dollar product or service, moves the fact set away from entertainment into the land of soft dollars (under the theory that but for your firmís brokerage business, your portfolio manager wouldnít be given the access to the CEOs).

You canít, of course, soft golf.

However, there seem to be very good reasons for not treating the golf-with-CEOs invitation as a soft dollar situation. One respected investment management lawyer pointed out that thereís no "nexus" between the commissions paid and the resulting golf game, and therefore it would not seem necessary to analyze the scenario as one involving soft dollars. She suggested that the analysis was more properly an entertainment issue.

"Weíre clearly in a gray area here," said another experienced CCO, oxymoronically. The CCO viewed the golf-with-CEOs situation as primarily an entertainment issue, rather than a question of soft dollars. "Iíd look to my gift and entertainment policy," he said. "Am I allowed to accept gifts from brokers? Is it lavish? Whatís the policy for reporting it?" A firmís entertainment policies "impose a bright line" for the staff to use, he noted. "What you really donít want" are employees "deciding it on an hoc basis."

"I think that there are a number of ways in which you can analyze the question," said a law firm partner, who asked not to be identified because his clients take differing views on the issue. "I think if there is a legitimate business purpose to the meeting and thatís the way that business gets done," there may not be a need to reimburse the brokerage firm for the golf fees, "particularly because there isnít a dollar-for-dollar use of soft dollars for particular events that happen." Added the lawyer: "You can make an argument that it is appropriate, because the truth is that that may be where the most value in attending the conference is."

On the other hand, he said, "if you want to be conservative and you are nervous about it, you can request to pay at the time you play" or can reimburse the broker-dealer later with hard dollars. The analysis, he added, "is fraught with a little bit of peril" and should be considered in light of an adviserís risk tolerance. If the activity is "disproportionately lavish," he said, "youíd be concerned about it." However, if it involves "little incremental cost," it may not be. "The truth is that a lot of business information gets passed on golf courses," said the lawyer.

In other words, apply a smell test. Depending on how risk adverse your nose is, you may just want to reimburse the brokerage firm for the golf fees and be done with it.

Thatís Pisarriís recommendation. She said sheíd advise her clients to pay the broker back for the golf fees. "As a practical matter, I wouldnít want to have to defend my golf fees," she said. "Itís in the nature of palm trees." She said that she would advise her clients to "pony up" the amount. "I donít know why you would want to defend it."

Interestingly, the CCO said she had checked around to see whether other advisers are hard dollaring golf fees. "The brokers maintain that nobody does," she said. However, she added, "they are more than willing to invoice us for something." While they typically donít invoice for entertainment, she said, "I imagine they probably would if we really pushed them."

Pisarri didnít put much stock in the brokerís "nobody does it" answer. That response, as well as its corollary, "everybody does it," is "not a particularly persuasive argument," she said. The charge for golf fees, she noted, appears on someoneís corporate card, somewhere, and therefore the brokerage firm knows what the fees are. "Itís not like it's a secret," she said. "I donít know why a broker would refuse to cooperate."

Lastly, hereís another conference-related trap to watch for: "The other thing about these conferences that I have advised clients," said Pisarri, "is that to the extent that you are also doing some networking and marketing while you are at these conferences, you might consider the advisability of doing a mixed used allocation and not softing the entire cost of the conference. At a lot of these things, there is subtle marketing that is going on, which of course would be overhead."