New York—Mutual funds are squawking about new
examinations detail being requested by examiners from the SEC’s New York
office, especially information requested relating to the potential misuse of
non-public information. Not specifically
cited by irate funds, but nevertheless of interest to our readers, the new exam
letters request information on proprietary soft dollar commissions—i.e.,
bundled commissions used to pay for broker/dealer research. This is an important step in the leveling of
proprietary research and third party research.
Examinations have never been a fun process for investment
advisors, frequently lasting weeks with SEC examination staff camped in
investor’s offices poring over documents.
We obtained a copy of a recent examination letter dated August, which
was sent to an investment advisor prior to the exam detailing the information
requested for the exam. We can
understand why investment advisors are upset—and why most hedge funds will
never willingly register with the SEC.
The exam letter is 27 pages, mostly detailing reams of information
required by examiners.
The items receiving the most attention are information
relating to the potential misuse of non-public information, which require
extensive information about PIPEs transactions.
Our attention was drawn to the soft dollar section, which requires
detail on both third party and proprietary soft dollar arrangements.
At the moment, soft dollars are mainly associated
with third party research (aka, independent or alternative research). Although the 28(e) was originally legislated
to preserve proprietary broker/dealer research as fixed commissions were
abolished in 1975, bundled commissions helped everyone forget this fact. Instead, the cumbersome arrangements used to
direct commissions to pay for third party research became synonymous with soft
dollars and the exam process helped to reinforce this misperception.
According to Theodore Eichenlaub of Adviser
Compliance Associates, which assists institutions on regulatory compliance, examiners
focused primarily on third party soft dollars because there was more
information available—soft dollar ratios, contracts and so on. Things started to change with the SEC’s
guidance on soft dollars in July 2006, which reiterated that proprietary
research paid for by bundled commissions is in fact soft dollars. And now, examiners are beginning to refocus
on this fact during the exam process.
Soft dollar related items requested by the
SEC are listed below. The information is
still skewed toward third party soft dollars, since there is more information
to disclose. However, the exam letter
asks for a listing of all proprietary soft dollar arrangements. As more large investment banks require
minimums to maintain research service levels, these arrangements will need to
be disclosed. CCA’s will also be
included.
The exam letter also requests detail on independent research
providers, including contract terms, fees, seminars attended, and issuers
covered. It is unclear why independent
research providers are singled out for SEC scrutiny during the exam process. Or, said another way, it is odd that the SEC
is not focusing on the seminars, management access, capital commitment and other
services included in full service commissions.
The current exams are a step in the right direction but are still
subject third party research to more scrutiny than proprietary research.
The full letter can be found at http://acacompliancegroup.com/news/documents/SEC_NYRO_Request_List-Aug2007.pdf
C. Soft-dollar Arrangements
1. Provide a list of the
soft-dollar arrangements, both third-party and proprietary, to which Adviser(s) were a party during
the Examination Period. This list should be provided in Excel format and should include the
following information for each arrangement:
a. The name of the broker or
other entity involved in each arrangement;
b. The nature of the goods or
services received by Adviser(s) under the arrangement;
c. Whether the goods or services
are third-party or proprietary or both;
d. A detailed description of how
the product or service is used by Adviser(s);
e. The approximate annual amount
of commissions on securities transactions needed to
satisfy each arrangement;
f. The soft-dollar ratio with
respect to each arrangement;
g. Whether the product or service
received is within the Section 28(e) safe harbor;
h. The allocation procedures used
if this item is considered to be mixed use;
i. The hard-dollar cost of each
product or service for the current year to date and the
previous year;
j. The total brokerage
commissions used to obtain each product or service for the current year to date and the previous
year;
k. The types of transactions used
to generate soft dollars for this agreement (i.e. equity or fixed income, listed or OTC,
agency or principal, or new issue designations);
l. The current amount of soft
dollar credits generated by securities transactions placed
by the adviser for the current
year to date and the previous year;
m. Whether or not invoices or
statement which record soft and/or hard dollars paid are
sent to Adviser and, if so, how
often; and
n. Whether the broker-dealer
providing the product or service is contractually obligated
to pay the cost of the product or service.
M. Independent Research Providers
1. Provide a list of all
independent research providers, if applicable, utilized by the Adviser during the Examination Period.
For all such service providers, provide the corresponding contract/terms of use, fee
schedule, and proof of payments.
2. A list of any seminars,
conferences, or other programs attended by the Adviser’s employees, officers, or agents that were
conducted, offered or paid for, directly or indirectly, by research providers or broker-dealers
during the Examination Period.
3. A list of the issuers that the
research provider provided research on; the format in which the research was delivered, and the
date the research was provided; and, whether the research provider and its affiliates are
investors in pooled investment vehicles managed by the Adviser and/or its affiliates.
