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Breaking News

May 31, 2007

ACA Insight Breaking News - IM Insight Breaking News -- SEC Chairman Asks Congress to Repeal Section 28(e)

The head of the SEC has announced that he wants Congress to get rid of soft dollars.

On May 17, SEC Chairman Christopher Cox sent nearly identical letters to the heads of the Senate Banking and House Financial Services committees, asking them to “repeal or substantially revise” Section 28(e), the soft dollar safe harbor. “I am concerned that this overly complicated provision of the law hurts investors and U.S. capital markets by protecting arrangements that involve substantial conflicts of interest, may contribute to higher brokerage costs, is difficult to administer, and may operate to impede the further development of efficient markets for brokerage as well as certain advisory services.”

We’re told that Cox delivered essentially the same message, albeit in more colloquial language, today before the National Italian American Foundation in New York City. The text of his speech is not expected to be released until tomorrow. News of Cox’s views on soft dollars was first reported by the Wall Street Journal.

In his letters to Committee Chairmen Senator Chris Dodd (D-CT) and Representative Barney Frank (D-MA), Cox explained why he believes that soft dollar arrangements are “troubling.” The potential to earn soft dollar credits, he noted, presents a conflict of interest whenever an adviser selects brokers. Cox pointed out that soft dollar arrangements hide an adviser’s costs in its clients’ commissions, rather than exposing them in the adviser's advisory fee.

Cox argued that soft dollars may drive up the cost of brokerage. Institutional trades, he said, can be executed at one or two cents per share. “Yet,” he added, “brokers may charge up to five cents per share for their brokerage services, and some significant portion of this charge is attributable to the research and other benefits the money manager obtains from the broker-dealer.”

He also cited the complexity in applying the safe harbor, asserting that it “requires the constant involvement of lawyers in business decisions.” Despite the SEC’s recent interpretative guidance, said Cox, the SEC staff continues to field inquiries on the topic.

While the safe harbor may have been justified back in 1975, said Cox, the securities industry has long since adapted to a world of unfixed commissions. “The number of money managers has grown significantly and the need to protect inefficient suppliers of research or money management is hardly a compelling argument to support the complicated safe harbor,” he said. Cox noted that the letter expressed his own views, “and not necessarily the views of the other Commissioners or of the President.” He said that he would be "pleased" to provide draft legislation to address the issue.

According to a recent investment management compliance survey jointly sponsored by ACA Compliance Group, the Investment Adviser Association, Amy Yuter of Old Mutual (US) Holdings Inc., and IM Insight, a majority of advisers steer away from soft dollar arrangements. Of the 415 compliance professionals who responded to the survey’s questions on soft dollar usage, 59 percent stated that their firm does not actively seek out soft dollar products and services and actually avoids soft dollar usage to the extent possible, often discarding unrequested proprietary brokerage firm research unread. However, 38 percent of the respondents said that their firm does rely on soft dollars to purchase products and services within the Section 28(e) safe harbor. Only 2 percent of the respondents said that their firms operated outside of the 28(e) safe harbor.

[Note to readers: Additional information on the survey results will be forthcoming in future issues of IM Insight].