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News September 18, 2006 Issue

Section 28(e) Compliance Should be Mandatory for All Advisers, Says ICI

The Investment Company Institute has not abandoned its fight to turn the Section 28(e) soft dollar safe harbor into a mandatory requirement for all investment advisers.

In a September 7 comment letter on the recently-issued soft dollar interpretive release, the ICI urged the SEC to propose a new anti-fraud rule prohibiting the use of soft dollars outside the safe harbor by all advisers. The group has made similar requests in the past, in comment letters to the SEC as well as in speeches by ICI officials.

Under current law, advisers to registered funds and ERISA clients are limited to soft dollar products and services that fall within the 28(e) safe harbor. Other types of advisers are free to disclose that they operate outside 28(e), and many hedge fund managers in fact do. This, said the ICI, creates an unlevel playing field that may cause brokerage firms to favor hedge fund advisers. "Without a level playing field," said the group, "all advisory clients will not be afforded the same protections relating to the adviserís use of brokerage, and funds will be placed at a regulatory and competitive disadvantage to other types of client accounts."

In addition to seeking a new soft dollar rule, the ICI commended the SECís revised approach to commission-sharing arrangements, saying it providing flexibility and clarification.

Other commenters wrote in praise of the SECís final interpretive release and to ask for additional clarification. For example, Bloomberg asked the SEC to clarify that an introducing/clearing agreement consistent with NYSE or NASD rules is not necessary for a client commission arrangement to come within the Section 28(e) safe harbor.

Bloomberg also noted that at one point in the release, the SEC stated that software that analyzes securities portfolios qualifies under the safe harbor as research because it reflects the expression of reasoning or knowledge. Elsewhere in the release, however, the SEC stated that software used for recordkeeping or administrative purposes, such as managing portfolios, and quantitative analytical software used to test "what if" scenarios related to adjusting portfolios, asset allocation, or portfolio modeling, do not qualify as "brokerage" under the safe harbor. That latter point could lead to confusion, said the company, which asked the SEC to clarify that portfolio-modeling software qualifies for the safe harbor if it assists the asset manager in making investment decisions.

Lastly, the U.K. Investment Management Association chided the SEC for failing to address disclosure issues: [T]he SECís regime might have more credibility if it also dealt adequately with disclosure," said the IMA. "The Commission should seriously consider whether disclosure of services obtained by managers under the safe harbor would be useful additional information to clients, after all it is their money."