SEC Not Likely to Unbundle (Phew), But May Ban Softing of Mixed Use Products
If you were spooked by the U.K. Investment Management Associationís soft dollar disclosure chart published in last weekís IM Insight, you can relax. For what appears to be the first time, an SEC official has publicly indicated that the SEC is not planning to go down that path.
"At this point we are not looking at unbundling execution and non-execution costs in full-service brokerage," SEC attorney-fellow Nancy Morris said last week. "We think that there are some difficult issues associated with trying to separate out commissions between research costs and execution costs." As a regulator, those issues "would be hard for us to ignore." She added that individual advisers still could choose to voluntarily unbundle their commission costs if they were so inclined. Morris, who sits on the SECís Soft Dollar Task Force, was speaking at last weekís ICAA/IA Week conference.
Instead of unbundling, Morris indicated that the task force is focusing "more on the disclosure route" as a way to facilitate information exchanges and "more intense conversations" between the adviser and clients about soft dollars. "What we are trying to do is get to the point where we are starting a good conversation between advisers and their clients about what is going on with their transaction costs," she said. The task force, she said, is currently "trying to figure out" what types of disclosures might be appropriate and helpful to clients.
Morris indicated that the SEC is inclined to address the soft dollar issue by rulemaking, rather than through an interpretative release. She noted, however, that any rulemaking likely would include some interpretative guidance. She predicted that the SEC would issue a soft dollar proposing release "probably sometime this summer."
Other elements of the rulemaking:
Softing of mixed use products may be prohibited. Morris said that mixed use products are coming under "serious scrutiny." The SECís Soft Dollar Task Force is "taking a very hard look at that," she said. "This is an area where we see really tremendous abuse . . . . The documentation is just very poor. Itís not out there. Thereís no real analysis being done." Morrisís co-panelist, Legg Mason general counsel Thomas Lemke, went further. "Iím going to make a prediction that mixed use products are probably going to go away," he said. Echoing Morris that the SEC has been concerned that advisers havenít been taking allocations as seriously as they should, Lemke noted that a few years ago, an allocation of "80 hard and 20 soft" was viewed as a red flag for the SEC.
Fewer things will be softable. "I think weíre looking to basically say that research services have to provide some sort of intangible, intellectual, or value-added content," said Morris. That, she noted, would exclude publications available to the general public, such as the Wall Street Journal. However, she acknowledged that there are grey areas, such as whether a trade journal with limited circulation should fall in or out of the "research" definition. Morrisís co-panelist, Alexandra Stocker of Sanderson & Stocker, pointed out that members of the general public can access some research on Yahoo Finance for $20 or $25 per report.
Morris acknowledged that the "intellectual content" concept raises difficult issues in the connection with stock quotation systems and other data feeds. "When is data just data?" she asked. "When is it then manipulated to the degree that it actually has intellectual content?" She noted that if data is put into a format that makes it "more easily available, readable, [and] you can click on [an item] and get additional data," it might be deemed to have some intellectual content. But a simple data feed running at the bottom of a screen, she added, would not seem to have intellectual content.
Morris also noted that the task force is likely to address the scope of brokerage services that are softable under Section 28(e). Brokerage services, she said, havenít received as much attention from the industry as research. She added that the task force hasnít "gotten too far along in our thinking on that."
Fund boards will receive more detailed disclosure than other advisory clients. Advisers to investment companies likely will be required to provide more detailed information about their use of fund commissions to fund boards, as compared to information provided to other clients. In turn, fund boards will be required to review information on "all things related to fund brokerage" on a regular basis, said Morris. The information to be provided to fund boards will be more than just soft dollar information, she explained: it will include total commission costs, price per share, conversion ratios, and the role of research. Providing a "significant amount" of transaction cost information to the board is designed to facilitate "a very informative discussion" between the board and the adviser about how commissions are utilized. The ultimate goal, said Morris, "is that those discussions will be fruitful and help to drive down commissions costs."
Books and records. Morris said that the SEC is likely to clarify the nature of books and records that advisers and broker-dealers have to keep regarding their soft dollar activities. SEC examiners, she said, have seen "a really lackadaisical approach to what has to be kept." She also said that the task force is looking at what types of records brokers have to keep and what kinds of information they should have to disclose to advisers. "There is a two-way street going on here," she said.
Directed brokerage for referrals may or may not be addressed. Morris said that directed brokerage has not been a main focus of the task force. Initially, she said, directed brokerage in the mutual fund area was on the groupís radar screen, but the issue subsequently was dealt with in the rulemaking process. She said that the topic of directed brokerage for adviser referrals continues to be in the background, but that she was not sure whether the issue would be dealt with in the upcoming soft dollar rulemaking or perhaps later down the line.