Now that you’ve seen what ACA Insight has to offer, don’t be without it. Subscribe now!

The weekly news source for investment management legal and compliance professionals

Current subscribers - please log in to the website in the upper right-hand corner

News October 25, 2004 Issue

There Are Different Ways to ‘Unbundle’ Commissions, Says Bergmann

Is the SEC going to require advisers to somehow put a dollar value on research and other components of full-service brokerage, and disclose that information to clients?

That unspoken question hung in the air during remarks made by Larry Bergmann, senior associate director in the SECís Division of Market Regulation, at the Securities Industry Associationís October 19 Mutual Fund Reform Update conference in New York. "Iím probably not going to tell you as much as you want to know about this," he said, noting that the SECís stance on soft dollars is "still in the formative stages."

Perhaps the most interesting aspect of Bergmannís remarks was his discussion of the different ways of "unbundling" the cost of execution and research embedded in full-service brokerage commissions. He said that the staff is looking at whether the cost of products and services that managers obtain with commissions should be quantified with greater transparency. The Task Force, he said, is "certainly paying attention to" the outstanding soft dollar-related proposals, many of which address "this whole question of unbundling." He pointed to Fidelityís March 2004 comment letter on the SECís transaction cost concept release, in which the fund group suggested that the SEC require fund advisers to quantify and separately report soft dollar research expenses as a percentage of assets, using values provided by broker-dealers. Bergmann also noted that unbundling is a key aspect of the U.K. Financial Services Authorityís soft dollar reform efforts.

When talking about unbundling the value of full-service commissions, said Bergmann, "it is important to make sure that we are all talking about the same thing." He gave the following examples of ways to "unbundle":

  • "Just listing the products and services that are being included in the commission."
  • "Separately listing them and then valuing each one of those products and services."
  • "Not only valuing them, but offering them separately so that the money manager perhaps can pick and choose what he wants to pay for with his commission dollars."

Bergmann said that the Task Force is "mindful that this is a global issue" and that "many firms have global operations." And, he added, the United Kingdom is "one of the principal outside-U.S. sites." He said the SEC staff has been communicating with the FSA not only for the SEC to see "where they are going," but also for the FSA to see "where we are going" and "whether or not there is the possibility to have some kind of parallel views on these issues." He noted that the FSA is awaiting feedback on unbundling from the U.K. investment management industry, which has been given a December deadline. "I think [the FSA has] indicated that all of the ideas they had are still on table."

IM Insight asked Bergmann whether, assuming that some sort of unbundling ultimately is required, advisers or brokers would have to come up with the valuation. In response, he said that valuation is "key" to the entire 28(e) issue. "Really, I think for me the critical question is: should broker-dealers be valuing services that they were providing the advisers, and is that useful information for the adviser in making its good faith determination under the statute? I think there are arguments both ways. We are still trying to determine whether or not we should make any recommendations in that area and we havenít reached any conclusions about that."

In his remarks, Bergmann touched on a number other soft dollar-related areas likely to be addressed by the SEC ó

What is Soft Dollarable? Bergmann referred to the language of Section 28(e)(3), which specifically defines "brokerage and research services" for purposes of the soft dollar safe harbor. That provision, he said, "is pretty important to what the Commission staff is focusing on." Bergmann noted that the provision "was set out in full" in the SECís 1986 interpretative release, but may have been overshadowed by the controlling principle enunciated in that release that the product or service provide "lawful and appropriate assistance" to the money manager, given the facts and circumstances. "I think in the following years, a number of people have forgotten that [Section 28(e)(3)] was in there" and have solely focused on whether things provided lawful and appropriate assistance, he said. After the 1986 release, some in the industry took an "extremely broad view" of what providing assistance was. For example, some took the position that even the "lighting in the room" was deemed to be "assistance" (presumably leading to soft dollarable electricity bills). While Bergmann noted that people generally seem to be backing off these extreme positions, "some of these expansive interpretations are still out there" and it is "one of the areas that we are taking close look at." He also noted that in some instances, high-priced delivery mechanisms are being softed. He questioned whether that was appropriate.

Bergmann also said that the staff is looking at "reverting back to the statutory terms" of "advice, analysis, and reports" in the definition of research. "This suggests to us that research involves things that have an intellectual content to them." He noted that a colleague recently remarked that "My computer has never independently offered me an investment idea." The implication, he added, is that computer hardware should not be within the scope of 28(e).

Multi-broker Arrangements. Bergmann said that the Task Force is focusing on "at least two basic kinds" of multi-broker arrangements: commission sharing and step-outs. He described commission sharing as an arrangement where one broker puts a portion of commissions into a pool of money and then at some point, sends a portion of that pool off to other broker-dealers that are providing some services back to the money manager. Those broker-dealers, however, may have "little or nothing to do with the trade," he said. Step-outs, he said, are where an executing broker-dealer might execute an entire 1000 share trade, but only clears and settles 900 shares. The executing broker then sends 100 shares to a second broker to be cleared and settled. The second broker gets the portion of the commission for that trade. Bergmann said that "often, the first broker doesnít know exactly what the commission arrangements are with the second broker, nor does he necessarily know what products and services they may be giving if they have a soft dollar arrangement." Bergman said that the Task Force was looking at whether the safe harbor extends to broker-dealers "that provide minimal or no services with respect to execution of the trade."

Documenting Allocation. Bergmann said the staff is looking at whether money managers are adequately documenting their allocation of soft dollars for mixed-used products and "is this documentation really worth the candle." In some cases, he said, "it seems to be . . . more of an aggravation than anything else." He also said that the staff was looking at whether fund boards are "sufficiently attuned to this process."

Third-party Research. Bergmann indicated that there will be no distinction between third-party research and proprietary research for purposes of the scope of the soft dollar safe harbor.