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News November 1, 2004 Issue

What’s in the SEC Pipeline?

Wondering where things are? Hereís a snapshot, provided by SEC officials speaking at last weekís NSCP conference.

E-mail guidance

. Itís coming. "We have heard absolutely, on both sides of the industry, both from brokers and advisers, that you would like some guidance," said OCIE general counsel John Walsh. "When it will happen and the precise form that it will [take] Iím not going to speculate on, but I am very hopeful that at some point in the not-to-distant future we will have something like that for you."

The betting money is that the SECís e-mail guidance is not going to suggest recommended best practices for e-mail retention. Instead, it sounds like it is going to repeat what weíve been hearing in speeches (if youíd have to keep it in paper, you have to keep it on e-mail; you can toss non-required e-mails but youíd better be sure what you are tossing is not required; be prepared to promptly cough up non-privileged e-mails during exam requests; be careful of spam filters, etc. etc.).

SEC Division of Investment Management associate director Robert Plaze emphasized that the e-mail issue wonít go away after the guidance is issued. "We are still going to want to look at e-mails," he said. Plaze added that revisions to the Advisers Act recordkeeping rule revisions are on the staffís "plate of things to do" and that e-mails will be covered in those revisions.

What might the rule change look like? OCIE officials have made clear that they would like to see a "business as such" standard added to the rule, bringing it in line with the standard for broker-dealer record retention.

And they may be inching toward a WORM standard, as well. At last monthís NRS conference, OCIE associate director Gene Gohlke indicated that in the past, the SEC has not imposed WORM requirements on advisersí records because "the alteration of documents has not been a significant problem in the investment advisory industry." However, referring to the events since September 2003, Gohlke added "I donít know whether the Commission would take that same approach today or not."

Of course, OCIEís wish list wonít necessarily translate into a rule change: the Division of Investment Management will make the policy calls on e-mails, promised IM director Paul Roye last month at the NRS conference.

Part 2 of Form ADV.

The SEC will "very likely" adopt new Part 2 in mid-2005, said Plaze. The SEC will provide "a very lengthy transition period" before the compliance date. Plaze noted that the NASD is building out the IARD system to accommodate the new form, which he said will be able to be uploaded on IARD with just a few keystrokes. He said that the charts and pictures "will all come through" on the Part 2 filing.

Soft dollars.

The Commission will be focusing on transparency and the scope of what is soft dollarable, said Plaze. He described transparency as the notion that a client should have an understanding of the benefits the adviser accrues from the clientís brokerage commissions. Right now, however, the disclosure clients see in Form ADV Part 2 "has more to do with the law firm that youíve hired to write the Part 2" than the adviserís actual practices, because "itís all written prospectively," he said. The notion of transparency, he added, is "Well, what did you actually do?" and how that affects the adviserís selection of brokers. "The trick, of course, is how to quantify this information, particularly in the context of bundled brokerage, and then how to convey it in ways that clients will find meaningful. Plaze noted that providing transparency for retail clients as well as more sophisticated institutional clients "is a very challenging effort."

In terms of narrowing the scope of what is soft dollarable, Plaze said that issues such as "what is overhead" are being considered. While research reports clearly will be covered by Section 28(e), "what about the hardware" used to transmit research reports to the adviser? "What about the wires, what about the electricity?"

Directed brokerage for fund sales.

The "news" here is that the SEC is talking tough about not taking violations lightly.

Plaze said that compliance officers at fund advisers should "pay serious attention to this rule amendment." He warned of dire consequences if examiners detect problems. "It is unlikely you are just going to hear about this in a deficiency letter," said Plaze. "This will be brought to the attention of other colleagues in the Commission" (namely, the SECís Division of Enforcement) "and you donít want to have that happen." Violations of the rule, he said, will be viewed as "very serious."

Plazeís advice: check your trading deskís annual brokerage allocation budget now to make sure that any budget in place does not include a budget for sales. "Youíve got to jump on that issue right away," he said. He also suggested that firms create an information barrier between the trading desk and "folks that sell the shares." Plaze added that the simple fact that a fund adviser directs brokerage to a broker-dealer that happens to sell the fundís shares "is not, in and of itself, unlawful, and is in fact permitted under the rules," provided procedures (per the rule) are in place.

Co-panelist Kirkpatrick & Lockhart partner Richard Marshall asked Plaze to confirm that the prohibition on fund directed brokerage for distribution "does not address the direction of brokerage to reward for the introduction of a hedge fund investor or the referral of an individual advisory account."

Plaze agreed, but noted that there is "a host of case law on undisclosed referrals." He said that directed brokerage arrangements give rise to "significant conflict of interests." He added, however, that the Commission did not "speak to those conflicts of interest in this particular rule."

Other items coming in the next few months:

Redemption fees, hard close rules, the thrift exemption, and fee-based brokerage rules.

Advertising rules.

Plaze said that the advertising rules are "on the list" but added that "as you know, we have a big list right now."†