New York—The SEC
is starting to receive comments on its proposed changes to Form ADV, and,
fittingly, the first few comments pertain to the soft dollar disclosure
provisions. The first comment was filed
by David Riedel, President of Riedel Research, a leading alternative provider
of emerging markets research. Riedel’s
comment focuses on the disparity of disclosure between soft dollar payments to
third party research and bundled commissions for proprietary research offered
by large investment banks.
Riedel’s comment
argues that the SEC should be requiring disclosure of all commission payments above
the cost of execution, not just payments to third parties. The comment highlights the grey area of the
proposed amendments to Form ADV—the SEC is requiring more narrative disclosure
relating to ‘bundled’ commissions but stopped short of requiring the disclosure
of amounts paid.
Riedel refers to
payments for third party research as soft dollars, whereas the SEC appears to
be treating both third party research payments and ‘bundled’ payments for
proprietary investment banking research as soft dollars, since both entail the
payment for research with commissions.
However, where Riedel’s comments are on the mark is that the SEC has not
shown the appetite to require the same level of disclosure for ‘bundled’
payments as is current market practice for third party research.
In fairness, the
SEC has been supportive of the spread of client commission agreements (CCAs, also
known as commission sharing arrangements, CSAs, outside the US), which allow
investors to consolidate trading with a fewer set of counterparties and pay for
research separately. CCAs are creating
more transparency by ‘unbundling’ research commissions from trading
commissions. However, in the US, the
large investment banks have largely refused to unbundle their own research,
whereas, in Europe, they have done so.
The SEC does not appear to be taking steps to rectify this.
The second
comment on Form ADV is from Bill George, who is well known to regular readers
of this blog as a passionate advocate of greater commission transparency. George’s comment focuses on the SEC’s omission
of the requirement for advisors to disclose whether they negotiate commission
rates, questioning how this could be burdensome when markets have been in a
negotiated commission environment since fixed commissions were abolished in
1975.
Comments, along
with the proposed rule (Release IA-2711, Mar. 3, 2008, Amendments to Form ADV) can be viewed with the following url: http://www.sec.gov/rules/proposed.shtml. The deadline for filing comments is May 16,
2008. Riedel’s comment is included
below:
Subject: File No. S7-10-00
From: David Riedel
Affiliation: President, Riedel Research
March 5, 2008
To whom it may concern:
I would like to weigh in on your
proposed changes to the Form ADV and in particular to the enhanced disclosure
within Item 12 with regard to Brokerage Practices in general and use of soft
dollars in particular.
I believe that your stated aim to
require a full disclosure of arrangements that we believe involve significant
conflicts of interest. would be best served by disclosure of all payments of
commission above the cost of execution rather than just those paid through a
soft dollar arrangement to a third party. You are quite right that the use of
client securities transactions to obtain research and other benefits creates
incentives that can result in conflicts of interest between advisers and their
clients – these conflicts are just as possible when the benefits are provided
by a single firm as when provided by two separate firms.
The bundling together of execution
and research by a single firm creates the same conflicts of interest that you
are concerned about with regard to soft dollars. In both cases the client is
being asked to absorb higher transaction fees to pay for a service that the
adviser considers valuable.
It is clear that the disclosure should ask whether the adviser uses client
securities transactions to obtain benefits other than transaction execution. If
the answer is Yes then the full range of conflicts it has when it accepts these
benefits and should be described and how it addresses those conflicts should be
disclosed.
When the item asks whether the
adviser pays up for benefits, this should not just be limited to soft dollar
benefits but rather to any situation where the adviser pays more than the
lowest available cost in the market for the execution of that transaction.
The comment in footnote 98 makes
this point very clearly. This note outlines the requirement that advisers to
disclose whether clients pay commissions higher than those obtainable from
other brokers in return for products and services. This is precisely the point
of my comment. Advisers should be required to state whether they pay
commissions higher than the lowest obtainable in the market and justify any
such arrangements. Not just soft dollar arrangements but any arrangement that
bundles execution with research or any other product (or) service.
Only by including all types of
commission arrangements that combine execution with other products and services
will you accomplish your goal of full disclosure of arrangements that involve
significant conflicts of interest.
Please do not hesitate to contact me
to discuss this in more detail.
Posted at 07:28 am by Sanford (Sandy) Bragg
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