-------------------- BEGINNING OF PAGE #1 -------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
Release No. 34-35375; IA-1469; S7-5-95
RIN: 3235-AG36
Disclosure by Investment Advisers Regarding Soft Dollar Practices
AGENCY: Securities and Exchange Commission
ACTION: Proposed rule and form.
SUMMARY: The Commission is proposing for comment a new rule and
form under the Investment Advisers Act of 1940 that would require
certain investment advisers to provide clients with an annual
report regarding their use of client brokerage. The proposed
report would include disclosure about an adviser's use of its
clients' brokerage commissions during the previous year,
including information about research and other services obtained
by the adviser with those commissions. The proposed annual
report is intended to provide investment advisory clients with
important information about the brokerage commissions they pay
and their advisers' receipt of "soft dollar" benefits from those
commissions.
DATES: Comments should be received on or before May 19, 1995.
ADDRESSES: Comments should be submitted in triplicate to
Jonathan G. Katz, Secretary, Securities and Exchange Commission,
450 Fifth Street, N.W., Washington, D.C. 20549. All comment
letters should refer to File No. S7-5-95. All comments received
will be available for public inspection and copying in the
Commission's Public Reference Room, 450 Fifth Street, N.W.,
Washington, D.C. 20549.
FOR FURTHER INFORMATION CONTACT: Eric C. Freed, Special Counsel,
or Robert E. Plaze, Assistant Director, (202) 942-0721, Office of
Disclosure and Investment Adviser Regulation, Division of
Investment Management, Securities and Exchange Commission, 450
Fifth Street, N.W., Washington, D.C. 20549.
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SUPPLEMENTARY INFORMATION: The Securities and Exchange
Commission today is proposing for comment:
(1) rule 204-4 [17 CFR 275.204-4] under the Investment
Advisers Act of 1940 [15 U.S.C. 80b-1 et seq.] ("Advisers Act"),
which would require an investment adviser registered or required
to be registered under the Advisers Act to deliver to its clients
an annual report on the adviser's direction of client brokerage
transactions and its receipt of research and other services in
connection with those transactions; and
(2) Form ADV-B under the Advisers Act, which would set forth
the information required to be included in the annual report.
EXECUTIVE SUMMARY
The Commission is proposing a new rule and form under the
Advisers Act to require each investment adviser ("adviser"),
registered or required to be registered under the Advisers Act,
that has the discretion to direct client brokerage transactions
and receives services other than execution in exchange for that
brokerage, to provide its clients with a report that would
contain information about its use of client brokerage. The
report would disclose for the adviser's most recently completed
fiscal year, (1) the twenty brokers to which the adviser directed
the largest amounts of commissions and certain other transaction-
related payments (collectively, "commissions"), (2) the three
brokers substantially all of whose services for the adviser were
execution services ("execution-only brokers") to which the
adviser directed the largest amounts of commissions, (3) the
aggregate amount of commissions directed by the adviser to each
broker listed and the percentage of the adviser's total
discretionary brokerage this amount represents, (4) the average
commission rate paid to each broker listed, and (5) for each
broker other than an execution-only broker, information
concerning products or services obtained from the broker. The
report would also disclose the percentages of the adviser's total
commissions that are directed to execution-only brokers, to other
brokers, and at the request of clients. The report would require
only information about an adviser's use of client brokerage on an
aggregate basis; it would not require separate information about
the brokerage of the adviser's various clients. The report would
be provided to existing advisory clients annually and to
prospective advisory clients no later than the time that an
advisory agreement is entered into.
I. BACKGROUND
Soft dollar practices are arrangements under which products
or services other than execution of securities transactions
("soft dollar services") are obtained by an adviser from or
through a broker in exchange for the direction by the adviser of
client brokerage transactions to the broker.-[1]- Soft dollar
practices are common in the institutional brokerage market.
According to an informal annual survey of investment advisers and
other institutions, nearly ninety percent of these institutions
engage in soft dollar arrangements, and more than forty percent
of commissions are directed primarily for the purpose of
obtaining research services.-[2]-
-[1]- See Securities Exchange Act Rel. No. 23170 (Apr. 23,
1986) [51 FR 16004 (Apr. 30, 1986)] ("Release 23170")
at I; Robert J. Moran & Cathy G. O'Kelly, Soft Dollars
and Other Traps for the Investment Adviser, 1 DePaul
Bus. L.J. 45, 45 n.5 (1989).
-[2]- Greenwich Associates, Soft-Dollars: Opportunities and
Challenges (special presentation of May 10, 1994);
(continued...)
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Soft dollar practices originally developed as a means by
which brokers provided discounts on brokerage commissions that
were fixed pursuant to exchange and commission rules. In 1975,
the Commission prohibited fixed commission rates-[3]- and, later
that year, Congress codified the Commission's action.-[4]- After
the Commission abolished fixed rates, concerns were raised
whether the soft dollar practices that had developed in the
context of fixed rates would continue to be consistent with
various state and federal laws, including the Advisers Act.-[5]-
Underlying these concerns is an adviser's fundamental
obligation under the Advisers Act (and state law) to act in the
best interest of its clients.-[6]- This duty requires the
adviser to obtain best execution of client transactions,-[7]- and
precludes the adviser from using client assets for its own
benefit or the benefit of other clients, at least without client
consent.-[8]- Upon the Commission's eliminating fixed commission
rates, some argued that an adviser could be deemed to have
violated this duty if the adviser caused a client's account to
pay anything but the lowest commission rates. If this view was
upheld, soft dollar arrangements could have been effectively
precluded by the decision to eliminate fixed commission rates.
Congress, in codifying the abolition of fixed commission
rates, responded to these concerns by enacting Section 28(e) of
the Securities Exchange Act of 1934 (the "1934 Act") [15 U.S.C.
78bb(e)], which provides a safe harbor for certain soft dollar
arrangements.-[9]- Section 28(e) provides, in pertinent part,
-[2]-(...continued)
Greenwich Associates, Institutional Equity Investors
1994 (statistical supp.) 3, 17.
-[3]- Securities Exchange Act Rel. No. 11203 (Jan. 23, 1975)
[40 FR 7394 (Feb. 20, 1975)].
-[4]- Securities Acts Amendments of 1975, Pub. L. No. 94-29,
89 Stat. 97, 107-08 (enacting Section 6(e)(1) of the
1934 Act [15 U.S.C. 78f(e)(1)]).
-[5]- S. Rep. No. 75, 94th Cong., 1st Sess. 70 (1975).
-[6]- See SEC v. Capital Gains Research Bureau, Inc., 375
U.S. 180, 194 (1963).
-[7]- Delaware Management Co., 43 S.E.C. 392, 396 (1967). An
adviser is obligated to use reasonable diligence to
select a broker who will "execute securities
transactions for clients in such a manner that the
client's total cost or proceeds in each transaction is
most favorable under the circumstances." Securities
Exchange Act Rel. No. 23170 (Apr. 23, 1986) [51 FR
16004 (Apr. 30, 1994)] ("Release 23170") at V (citing
Kidder, Peabody & Co., 43 S.E.C. 911, 915 (1968)). An
adviser should consider the full range and quality of
the broker's services, including the value of research
received, in assessing whether a broker will provide
best execution. Id.
-[8]- Restatement (Second) of Trusts 170 comment a, 216
(1959).
-[9]- Securities Acts Amendments of 1975, Pub. L. No. 94-29,
89 Stat. 97, 161-62.
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that an adviser with investment discretion over an account will
not be deemed to have acted unlawfully or to have breached its
fiduciary duty by causing the account to pay a higher commission
to a broker that provides research benefiting the adviser's
accounts. To rely on the Section 28(e) safe harbor, an adviser
must determine in good faith that the commissions paid are
reasonable in relation to the value of the brokerage and research
services provided, either in terms of the particular transaction
or the adviser's overall responsibilities towards its
discretionary accounts.-[10]-
Section 28(e) modifies a fiduciary's strict duty to act in
the best interest of each client with respect to the management
of each client's assets. Thus, it permits an adviser to cause a
client to pay higher commissions than otherwise are available to
obtain research that may not be used exclusively for the benefit
of the client or used to benefit the client at all. Section
28(e), however, does not afford a safe harbor with respect to all
conflicts of interest between the adviser and its clients that
may arise from soft dollar arrangements. For example, soft
dollar arrangements may cause an adviser, in order to obtain soft
dollar services, to violate its best execution obligations by
directing client transactions to brokers who could not adequately
execute the transactions. Soft dollar arrangements also may give
advisers incentives to trade client securities inappropriately to
generate credits for soft dollar services.-[11]-
Soft dollar practices also diminish the ability of a client
to evaluate the expenses it incurs in obtaining portfolio
management services and may hinder the ability of the client to
-[10]- The Commission has stated that a product or service may
legitimately be considered a "brokerage or research
service" covered by the safe harbor if it provides
"lawful and appropriate assistance to the [adviser's]
decision-making process." Release 23170, supra note 1.
The Commission's Division of Market Regulation has
addressed the types of transactions that are afforded
the protection of the safe harbor. See U.S. Department
of Labor (pub. avail. July 25, 1990) (safe harbor does
not extend to principal, riskless principal and futures
transactions); Hoenig & Co. (pub. avail. Oct. 15, 1990)
(same); Instinet Corporation (pub. avail. Jan. 15,
1992) (safe harbor does apply to agency transactions in
equity securities on a computer-based real time market
information and brokerage system and after-hours order
matching system).
-[11]- See Securities and Exchange Commission v. Galleon
Capital Management, Litigation Rel. No. 14315 (Nov. 1,
1994). The Commission's complaint in Galleon, in
addition to alleging excessive trading in order to
generate soft dollar credits, alleged that the adviser
requested brokers to make soft dollar payments to a
consulting firm, and that these payments eventually
were rebated to the adviser. See also Letter from
Bradford P. Schaaf, Chairman, and Victor J. Fontana,
President and Chief Executive Officer, Autranet, Inc.
to Barry P. Barbash, Director, Division of Investment
Management and Brandon Becker, Director, Division of
Market Regulation (Nov. 10, 1994) ("Autranet Letter")
(proposing that the Commission prohibit a broker from
requiring an adviser, by contract or understanding, to
commit to direct any specified amount of commissions to
the broker in order to receive soft dollar services).
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negotiate fee agreements, because the costs of soft dollar
services are "hidden" from investors in brokerage commissions.
By permitting advisers to use their clients' transactions to pay
for research services that they otherwise would have to purchase
with "hard dollars," soft dollar arrangements permit advisers to
charge fees that do not fully reflect the cost of portfolio
management. Advisers that do not engage in soft dollar
arrangements may be put at a competitive disadvantage if they pay
for services with hard dollars and attempt to pass the cost of
these services on to clients through higher fees.
Congress recognized the conflicts that soft dollar practices
present and provided in Section 28(e) authority for the
Commission to require advisers to disclose to their clients their
policies and practices with respect to the use of client
commissions.-[12]- The Commission has never adopted rules under
Section 28(e),-[13]- but has instead required certain disclosure
in Part II of Form ADV, which specifies the content of the
disclosure document or "brochure" that an adviser is required to
provide to clients before entering into advisory
relationships.-[14]- If soft dollar arrangements are a factor in
selecting brokers to effect client transactions, the brochure
must disclose the nature of the adviser's soft dollar practices,
including: (i) the services that the adviser obtains through soft
dollar arrangements; (ii) whether clients may pay higher
commissions ("pay up") as a result of the arrangements; (iii)
whether soft dollar services are used to benefit all client
accounts or only those accounts the brokerage of which was used
to purchase the services; and (iv) any procedures that the
adviser uses to allocate brokerage.-[15]-
Two broker-dealers, Goldman, Sachs & Co. and Morgan Stanley
Group Inc., themselves providers of research services to
advisers, have strongly criticized the effectiveness of current
disclosure requirements.-[16]- Current disclosure primarily
-[12]- Section 28(e)(2) [15 U.S.C. 78bb(e)(2)].
-[13]- In 1976, the Commission proposed rule 28e2-1 under the
1934 Act, but the rule was never adopted. See note 41
infra.
-[14]- Rule 204-3 under the Advisers Act [17 CFR 275.204-3]
requires that a registered investment adviser deliver
the brochure to a prospective client before entering
into an advisory contract with the client, and,
annually thereafter, provide or offer to provide the
client with the brochure. The Commission is not at
this time proposing to amend the Form ADV requirements
regarding disclosure of soft dollar arrangements. The
Commission, however, is considering whether changes to
these requirements would be appropriate, and may
propose changes in connection with future revisions to
Form ADV.
-[15]- Item 12 of Part II of Form ADV. Registered investment
companies are required to include similar disclosure in
their Statements of Additional Information. See, e.g.,
Item 17 of Form N-1A [17 CFR 239.15A, 274.11A].
-[16]- See Future of the Stock Market: Soft Dollars, Hearing
Before the Subcomm. on Telecommunications and Finance
of the House Comm. on Energy and Commerce, 103d Cong.,
1st Sess. (1993) ("1993 Hearings") (testimony of David
(continued...)
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focuses on the policies and practices that the adviser intends to
follow with respect to the use of client brokerage.-[17]- This
disclosure does not, Goldman, Sachs and Morgan Stanley assert,
adequately disclose to clients the extent to which an adviser has
soft dollar commitments or the specific benefits that accrue to
the adviser from the use of the client brokerage. These brokers
have proposed that the Commission adopt a requirement that
advisers periodically report to clients the soft dollar benefits
that they have received and the specific value of those benefits,
as well as certain information about how the brokerage of each
client was directed (the "Goldman/Morgan Proposal").-[18]- Other
participants in soft dollar arrangements, organized by the
Alliance in Support of Independent Research, have argued that
current client disclosure by advisers is adequate and that the
Goldman/Morgan Proposal is anti-competitive and
discriminatory.-[19]-
The difference in the views of these two groups may reflect
the differences in the ways the two groups provide research
services to advisers and the effect that the Goldman/Morgan
Proposal would have on each group. Goldman, Sachs and Morgan
Stanley operate as "full service brokers" and provide a variety
of execution, research and related services to clients. An
adviser who executes client securities transactions through these
firms typically receives research services developed by the firms
("proprietary" soft dollar services), much of which is provided
without being directly requested by the adviser. The cost of
such services generally are bundled in the overall commission
charged by the full service broker. In contrast, a "soft dollar
broker" typically provides advisers with services prepared or
-[16]-(...continued)
M. Silfen, Partner, Goldman, Sachs & Co. and Anson M.
Beard, Jr., Managing Director, Morgan Stanley Group
Inc.).
-[17]- The Commission has instituted a number of enforcement
actions against advisers based, at least in part, on
the failure to disclose soft dollar arrangements
adequately. See, e.g., Securities and Exchange
Commission v. Galleon Capital Management, supra note
11; Kingsley, Jennison, McNulty & Morse, Inc.,
Investment Advisers Act Rel. No. 1396 (Dec. 23, 1993);
DeMarche Associates, Investment Advisers Act Rel. No.
1392 (Nov. 23, 1993); Jack Allen Pirrie, Investment
Advisers Act Rel. No. 1284 (July 29, 1991); Robert
Michael Lee, Investment Advisers Act Rel. No. 1249
(Sept. 17, 1990); Patterson Capital Corp., Investment
Advisers Act Rel. No. 1235 (June 25, 1990).
-[18]- The Goldman/Morgan Proposal will be placed in the
public comment file for the Commission's proposal.
-[19]- See Letter from The Alliance in Support of Independent
Research to Jonathan G. Katz, Secretary, Securities and
Exchange Commission (Oct. 17, 1994), Commission File
No. S7-22-94 ("Alliance Letter"); see also Autranet
Letter, supra note 11. The Alliance in Support of
Independent Research is "a group of broker-dealers,
money managers and research firms sharing a common
interest in fostering a favorable regulatory
environment in which independent research services and
products may be furnished to the money management
community."
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produced by parties other than the broker ("third-party" soft
dollar services) in exchange for the allocation of specified
amounts of commission dollars.-[20]- In these types of
arrangements, an explicit price denominated in commission
dollars, rather than in hard dollars, is typically attached to
the research.-[21]-
The Goldman/Morgan Proposal would affect the two groups of
brokers differently. Because proprietary soft dollar services
are not offered for a specific price in commission dollars, under
the Goldman/Morgan Proposal, disclosure would be required only
about the price and value of third-party soft dollar services.
Soft dollar brokers argue that if the Commission required more
extensive disclosure of third-party soft dollar services than
proprietary soft dollar services, advisory clients might be led
to believe that advisers derive benefits from soft dollar brokers
at the clients' expense that they do not derive from full service
brokers, when, in fact, both types of firms confer benefits on
advisers.-[22]- As a result, advisers might be discouraged from
using soft dollar brokers.
Representatives of some investment advisers have asserted
that current disclosure requirements are adequate.-[23]-
According to these advisers, clients rarely request information
about the soft dollar benefits that the adviser receives, and
those that are interested currently may obtain the information on
request.-[24]- Other investment advisers, however, argue that
-[20]- In 1980, the Commission stated that research provided
through third-party arrangements falls within Section
28(e) of the Exchange Act, even if the money manager
participates in selecting the research services
provided to it and the research is delivered directly
to the money manager by the third party. Securities
Exchange Act Rel. No. 17371 (Dec. 12, 1980) [45 FR
83707 (Dec. 19, 1980)]. The Section 28(e) safe harbor
is not available to third-party soft dollar
arrangements unless, among other things, the broker is
obligated to the third party to pay for the services.
Release 23170, supra note 1, at III; Kingsley,
Jennison, McNulty & Morse, Inc., supra note 17.
-[21]- Some full service brokers also will enter into third-
party soft dollar arrangements with advisers.
-[22]- See Alliance Letter, supra note 19.
-[23]- See, e.g., 1993 Hearings, supra note 16 (statement of
Holly A. Stark, Senior Vice President, Dalton, Greiner,
Hartman, Maher & Co.).
-[24]- Many pension plans require some form of soft dollar
reporting from their money managers, primarily in
response to a pronouncement of the Department of Labor,
the principal federal regulator of employee benefit
plans under the Employee Retirement Income Security Act
of 1974 ("ERISA"), concerning the ongoing duty of plan
fiduciaries to monitor the use of soft dollars by
managers. See ERISA Technical Release No. 86-1.
Section 15(c) of the Investment Company Act of 1940 [15
U.S.C. 80a-15(c)] requires the directors of a registered
investment company to request and review, and the company's
adviser to supply, such information as may reasonably be
(continued...)
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the nature of the conflicts involved in soft dollar arrangements
warrant more extensive client disclosure than is currently
required.-[25]-
The Commission staff considered issues related to soft
dollars in its "Market 2000" report on the equity markets
released in January 1994.-[26]- In that report, the staff
recommended that quantifiable information about soft dollar
services be required to be provided to advisory clients.-[27]-
The report also stated that "[m]ost importantly, . . . any new
disclosure requirements should apply equitably. Thus, research
and other services obtained either from [full service] firms or
[soft dollar] firms should be subject to disclosure."
II. DISCUSSION
The Commission believes that, in light of the conflicts of
interest presented by soft dollar arrangements, additional
-[24]-(...continued)
necessary to evaluate the terms of the advisory contract
between the adviser and the investment company. As
discussed above, soft dollar arrangements may bear upon the
reasonableness of advisory fees. See text accompanying note
12 supra. Investment company advisers that engage in soft
dollar arrangements therefore must provide their boards of
directors with information regarding soft dollar
arrangements. See Release 23170, supra note 1, at IV.B.3.
Various institutional investors have expressed their views
on soft dollar arrangements. See 1993 Hearings (statement
of Fred G. Weiss, Chairman, Financial Executive Institute's
Committee on Investment of Employee Benefit Assets
("CIEBA")). Mr. Weiss stated that CIEBA, which represents
150 corporate benefit plan sponsors with assets of
approximately $600 billion, was unable to develop a clear
consensus on whether soft dollar practices were desirable or
not. CIEBA did, however, call for more comprehensive
reporting of soft dollar arrangements at a firm-wide level
to supplement the client-specific information that most of
its members currently receive. Other institutional
investors believe that current disclosure is adequate. See
1993 Hearings (written statement of State Board of
Administration of Florida). In addition, the Institutional
Investors Committee of the National Association of
Securities Dealers, Inc. ("NASD Committee"), which includes
representatives of institutional investors, advisers, and
brokerage firms, submitted a recommendation to the
Commission's staff for additional soft dollar disclosure.
The NASD Committee's recommendation was approved by the
NASD's Board of Governors. The NASD Committee's
recommendation will be placed in the public comment file for
the Commission's proposal.
-[25]- See Letter from Louis R. Cohen and Marianne K. Smythe,
Wilmer, Cutler & Pickering to Jonathan G. Katz,
Secretary, Securities and Exchange Commission (Oct. 17,
1994) (on behalf of Investors Research Corp.)
("Investors Research Letter"), Commission File No. S7-
22-94.
-[26]- See U.S. Securities and Exchange Commission, Division
of Market Regulation, Market 2000: An Examination of
Current Equity Market Developments (Jan. 1994).
-[27]- Id. at V-15.
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disclosure about these practices may be warranted. While current
disclosure may provide sufficient notice to a client that the
adviser has these conflicts, it may not provide the client with
sufficient information to permit it to assess the extent to which
the adviser obtains soft dollar services or pays up for those
services, or the types of services that the adviser obtains
through soft dollar arrangements. Enhanced disclosure may
provide existing clients with information useful in negotiating
limits on the use of their brokerage, and enable prospective
clients to make better informed choices of advisers.
The Commission is therefore proposing that certain
registered advisers be required to provide clients with annual
reports setting forth certain information about their use of
client brokerage and the soft dollar services each adviser
received during its most recently completed fiscal year.-[28]-
The proposal is intended to provide an advisory client with
information that can be used to evaluate the extent to which the
client benefits from the adviser's brokerage practices, the
extent to which the adviser benefits, and whether the client
should attempt to limit the adviser's use of its brokerage.
Consistent with the recommendations of the staff in the Market
2000 report, the proposed disclosure requirements would not
impose different requirements on third-party and proprietary soft
dollar arrangements.
A. The Annual Report in General
The Commission is proposing a new rule under the Advisers
Act, rule 204-4, that would require any adviser, registered or
required to be registered under the Advisers Act, that has
brokerage discretion-[29]- over any client account and that
receives soft dollar services to deliver an annual report to
clients on its use of client brokerage. The contents of the
annual report would be specified in new Form ADV-B.
The core of the annual report would be a table disclosing
information regarding the adviser's direction of client
brokerage. The table would list the twenty brokers other than
execution-only brokers ("research brokers") to which the adviser
directed the greatest amount of client commissions,-[30]- and the
three execution-only brokers to which the adviser directed the
greatest amount of client commissions during its most recent
fiscal year.-[31]- For each broker listed, the table would
disclose: the aggregate amount of commissions directed by the
adviser to the broker; the percentage of the adviser's
discretionary brokerage commissions that this represents; the
-[28]- The proposed amendments would not require that advisers
provide each client with information about how that
client's transactions were directed. See Section II.F
infra.
-[29]- The definition of "brokerage discretion" is discussed
at notes 58-59 and accompanying text infra.
-[30]- For the purposes of the amendments, "commissions" would
include amounts of mark-ups and mark-downs on principal
transactions if those amounts are included on the
confirmation of the transaction required under rule
10b-10 under the 1934 Act. See Section II.E infra.
These mark-ups and mark-downs, however, are not
commissions for purposes of Section 28(e). See note 10
supra.
-[31]- The definition of "execution-only broker" is discussed
at notes 36-38 and accompanying text infra.
-------------------- BEGINNING OF PAGE #10 -------------------
average commission rate (in cents per share) paid to the broker;
and a description of the soft dollar services provided by the
broker.-[32]-
The table would provide an overview of the brokers used by
an adviser to execute client transactions, the commissions
charged by the brokers, and the soft dollar services received
from research brokers. This disclosure is intended to assist an
advisory client in evaluating the adviser's use of its brokerage,
including whether the client could be paying lower commissions,
whether the adviser is obtaining soft dollar services that can be
used to benefit the client, and whether the advisory fee charged
to the client is appropriate in light of the services that the
adviser pays for with client commissions. Institutional clients
using the services of more than one adviser and prospective
clients considering different advisers will be able to use the
table to compare advisers' use of brokerage, including the
commission rates that they negotiate and the types of services
that they receive. The disclosure regarding execution-only
brokers would assist clients in making these determinations by
providing information about the availability of brokerage
alternatives, and, by implication, the effect that soft dollar
services may have on commission rates.-[33]-
The table would be followed by certain data concerning the
adviser's direction of brokerage: the percentages of the
adviser's total brokerage that are directed (1) by the adviser to
research brokers, (2) by the adviser to execution-only brokers,
and (3) pursuant to specific client instructions.-[34]- This
data would provide clients with an overall picture of how the
adviser directs brokerage.
B. Disclosure of Brokers
As noted above, the report would be required to include
information about twenty research brokers and three execution-
only brokers.-[35]- Limiting the required disclosure to this
number of brokers is intended to result in reports that provide
-[32]- Items 2-3 of proposed Form ADV-B. For purposes of
determining the amount of commissions and the
corresponding percentage of the adviser's discretionary
brokerage that this amount represents, sales loads on
transactions in investment company shares would be
considered commissions. Because sales loads typically
are not calculated on a cents per share basis and could
potentially distort the average commission rate data,
sales loads would not be considered in calculating
average commission rates. Instruction 3 to Item 2 of
proposed Form ADV-B.
-[33]- The Commission recognizes that the use of execution-
only brokers would not be appropriate or possible in
many circumstances. The proposed disclosure about
execution-only brokers is not intended to imply that
such brokers could have been used in all circumstances.
Furthermore, an adviser would be permitted to explain
its policies regarding the use of execution-only
brokers in a narrative portion of the annual report.
See General Instruction 6 to Proposed Form ADV-B.
-[34]- Item 4 of proposed Form ADV-B.
-[35]- For purposes of the annual report, a "broker" would
include a bank that is not registered as a broker-
dealer under the 1934 Act. Instruction 1 to Item 2 of
proposed Form ADV-B.
-------------------- BEGINNING OF PAGE #11 -------------------
useful information in a relatively concise manner. Comment is
requested whether the proposed numerical thresholds are
appropriate. Comment is also requested whether, as an
alternative, disclosure should be required about brokers to which
the adviser directed more than a specified percentage of its
brokerage, such as one percent.
For the purposes of the amendments, a broker would be
considered an "execution-only" broker if substantially all of the
services that the broker provides to the adviser are execution
services, i.e., effecting securities transactions and performing
functions incidental to or required in connection with effecting
those transactions.-[36]- Consequently, a broker would not be
permitted to be considered an execution-only broker if it
provided any significant amount of soft dollar services to the
adviser, even if the services were not solicited or used by the
adviser.-[37]- If a broker provided only execution services to
an adviser, however, the adviser would include the broker as
execution-only even if the broker provided additional services,
such as research, to its other customers. The definition of
execution-only broker would include automated trading systems
(e.g., the Instinet and Lattice systems) if the adviser received
only execution and execution-related services as a result of
using the system, regardless of whether the system itself is
required to be registered as a broker-dealer under the 1934
Act.-[38]-
An adviser that did not utilize any research brokers or that
did not utilize any execution-only brokers would be required to
so state under the appropriate heading in the table.-[39]- An
adviser that directed client commissions to fewer than twenty
research brokers and/or fewer than three execution-only brokers
would be required to disclose under the appropriate headings
those brokers to which it did direct client commissions. As a
result, an adviser's annual report would always include some
reference to the existence of execution-only brokers. Comment is
requested whether there are better ways to disclose to clients
the availability and cost of brokerage alternatives. For
instance, comment is requested whether an adviser should be
required to disclose execution-only brokers that offered to
execute client transactions. Similarly, comment is requested
-[36]- Instruction to Item 3 of proposed Form ADV-B. The
definition of execution-only broker is derived from
Section 28(e)(3)(C) of the 1934 Act [15 U.S.C.
78bb(e)(3)(C)]. Under that section, custody of
securities is a function incidental to effecting a
transaction in the securities.
-[37]- A broker would be permitted to be considered an
execution-only broker if it provided a minimal amount
of soft dollar services to the adviser, such as a
single research report or a single contact with a
securities analyst.
-[38]- Instruction to Item 3 of proposed Form ADV-B.
Typically, the sponsor of an automated trading system
will be required to be registered as a broker-dealer
under the 1934 Act. An automated trading system would
be included in the definition of broker in Form ADV-B
if a fee is charged for using the system, regardless of
the basis for the fee (e.g., a flat usage fee or
transaction-based fees).
-[39]- Items 2 and 3 of proposed Form ADV-B.
-------------------- BEGINNING OF PAGE #12 -------------------
whether the table should include disclosure regarding all brokers
used by the adviser.-[40]-
Comment is requested generally on the definition of an
execution-only broker, and whether the proposal's classification
of brokers into two types, execution-only and all others, is
appropriate or practicable. Instead of classifying brokers by
type, the Commission considered proposing that advisers be
required to classify brokers or specific trades based upon the
purposes for which the trades were directed to the broker (e.g.,
execution or research). Under this approach, trades directed to
a broker that provided soft dollar services could be considered
to be directed for the purposes of execution if the services were
a minimal factor in directing the brokerage. The Commission is
not proposing this approach because determining the purposes for
which brokers are used or individual trades are directed may be
impracticable and burdensome.-[41]- The proposed approach, which
would not permit an adviser to treat a broker from whom it
receives significant soft dollar services as an execution-only
broker, seeks to reduce the burden on advisers by providing a
more objective basis for classifying brokers. Nevertheless,
comment is requested whether the annual report should require
advisers to classify brokers or trades by the purposes for which
the adviser directed the brokerage.
C. Disclosure of Products and Services Received
The annual report would describe the soft dollar services
received by the adviser from each research broker listed. Except
as discussed below, soft dollar services would be required to be
identified specifically.-[42]- The producer of a third-party
soft dollar service would be identified unless its name was
evident from the name of the product. This information is
intended to permit a client to assess whether it benefits from
the soft dollar services that the adviser receives and,
consequently, whether it should attempt to limit the adviser's
use of its brokerage.
In many cases, an adviser receives research reports from a
broker or is given access to the broker's securities
professionals in exchange for the direction of brokerage. An
adviser would not be required to list separately every report
that it received or each professional with whom it had contact.
-[40]- In order to keep the report at a manageable length, an
adviser could be permitted merely to indicate whether
or not it received soft dollar services, rather than to
identify the services received, from brokers that were
not among those it used most frequently (e.g., the top
twenty).
-[41]- In 1976, the Commission proposed rule 28e2-1 under the
1934 Act, which would have required advisers to make
certain disclosures to clients concerning soft dollar
practices in a separate annual report. Securities
Exchange Act Rel. No. 13024 (Nov. 30, 1976) [41 FR
53356 (Dec. 6, 1976)]. The proposed rule, which was
not adopted, would have required, among other things,
narrative disclosure concerning research received "in
return for" brokerage. Commenters stated that it was
impracticable to determine whether research was
obtained "in return for" specific services,
particularly when the research was not solicited. See
Securities Exchange Act Rel. No. 10569 (Jan. 30, 1979)
[44 FR 7864 (Feb. 7, 1979)] ("Release 10569").
-[42]- Instruction 7 to Item 2 of proposed Form ADV-B.
-------------------- BEGINNING OF PAGE #13 -------------------
Instead, an adviser would be permitted to refer to these services
generically according to the following categories: (1) analyses
and reports on specific securities, issuers or industries, (2)
political or economic analyses or reports, or (3) access to
securities analysts.-[43]- All other services, including
computer hardware, software, databases, and on-line services,
financial or other publications available by subscription, and
any products or services falling outside the scope of Section
28(e) of the 1934 Act, would be required to be identified
specifically.
Comment is requested whether soft dollar services should be
identified in this manner. Should the Commission require more
specific disclosure of research reports or access to securities
analysts or other professionals, or permit general descriptions
of other services? Comment is requested whether, either in lieu
of or in addition to separate identification of the services
received, soft dollar services should be required to be
classified into specified categories, and, if so, what those
categories should be.-[44]-
In addition to requiring a description of the soft dollar
services received, the Goldman/Morgan Proposal would have
required that an adviser disclose the price in commission dollars
and fair market value of each third-party soft dollar service
(which typically will be provided at an explicit price). As
noted above, the Goldman/Morgan proposal would not require this
disclosure regarding proprietary soft dollar services, as these
services are not explicitly assigned a price. Price and fair
value information may be useful as an expression of the value of
the soft dollar services obtained by the adviser.-[45]- The
Commission is concerned, however, that unless the values of
proprietary soft dollar services are also included in the report,
the information provided to the client would be incomplete and
may distort client understanding about the benefits that advisers
receive through client brokerage. Clients, for example, may
incorrectly believe that soft dollar services are not a
consideration in an adviser's direction of client brokerage to
full service brokers or that third-party soft dollar services are
of greater value (either to advisers or clients) than proprietary
-[43]- Id.
-[44]- In connection with its annual survey of institutions
regarding their brokerage practices, see note 2 and
accompanying text supra, Greenwich Associates uses the
following nine categories of soft dollar services:
performance measurement, third-party research,
corporate fundamental databases, technical analysis
software, portfolio modeling and strategy software, on-
line stock price quotations, specialized political or
economic analyses, terminals and computers, and custody
services. Greenwich Associates, Institutional Equity
Investors 1994 (statistical supp.) 19.
-[45]- The Commission recently proposed that estimates of the
value of non-monetary payments for order flow be
disclosed to customers of brokers receiving such
payments. Securities Exchange Act Rel. No. 34903 (Oct.
27, 1994) [59 FR 55014 (Nov. 2, 1994)]. Payment for
order flow is payment by a broker, dealer, securities
exchange, securities association or exchange member to
a broker or dealer in return for the routing of
customer orders to the broker, dealer, securities
exchange, securities association, or exchange member.
-------------------- BEGINNING OF PAGE #14 -------------------
soft dollar services. Moreover, the Goldman/Morgan Proposal may
provide an investment adviser an incentive to direct brokerage to
a full service broker rather than a soft dollar broker for the
same types of soft dollar services, simply because of differing
client reporting requirements. This consequence may not be in
the best interests of advisory clients and may be unfair to soft
dollar brokers. Thus, consistent with the staff's
recommendations in the Market 2000 report, the Commission is not
proposing that only third-party soft dollar services be valued.
The Commission also considered requiring advisers to report
the fair market value of all soft dollar services, regardless of
their source. Because there often is no agreed upon price for
proprietary soft dollar services, their fair market value may not
readily be ascertainable. One approach might be to require
advisers to disclose the cost to the broker of producing
proprietary soft dollar services. The cost of producing
services, however, may not reflect their fair market value, and
an adviser may not be able to verify cost information provided by
brokers.-[46]- Alternatively, the value of soft dollar services
to the adviser receiving them could be required to be disclosed,
but it may be inappropriate and misleading to reflect services
that the adviser did not solicit or use as having no value.-[47]-
An adviser could be required to make a good faith estimate
of what the proprietary soft dollar services would have cost in
an arms-length transaction.-[48]- This approach would require
advisers to report positive values for unsolicited and unused
services, which could lead investors to believe that the adviser
(or the client) substantially benefited from the direction of the
-[46]- In addition, it is unclear how a broker's "cost" should
be determined. An "average cost" could be obtained by
dividing the cost of producing the services by the
number of recipients. "Marginal cost" would measure
the actual cost of providing the research to the last
adviser. Full service brokers frequently distribute to
advisers and other customers research services that
were initially produced for other purposes. The
marginal cost of such research might be only the cost
of its distribution.
-[47]- An adviser could be required to report only those
proprietary soft dollar services for which it
specifically directed brokerage. Such a limitation,
however, would require highly subjective determinations
by advisers, and, as a practical matter, might elicit
disclosure about only third-party soft dollar services.
-[48]- This approach was suggested by one commenter on the
Commission's recent proposal to require that mutual
fund expenses paid by brokers should be included in
fund expense and performance data. See Investors
Research Letter, supra note 25. In that proposal, the
Commission requested comment whether the value of
research services received by a fund's adviser should
also be included in fund expenses, and how the research
should be valued. See Investment Company Act Rel. No.
20472 (Aug. 11, 1994) [59 FR 42187 (Aug. 17, 1994)], at
II.A.1. Most commenters on the proposal, however,
opposed the inclusion of research services in fund
expenses, and those commenters that favored it
generally provided little guidance regarding how to
value proprietary services.
-------------------- BEGINNING OF PAGE #15 -------------------
brokerage when, in fact, receipt of the services was incidental
to brokerage direction decisions made wholly on the basis of the
broker's execution capabilities. In addition, good faith
estimates may be very difficult to make if the services provided
are unlike those available for hard dollars. In this regard, the
Commission is concerned with the burden that a good faith
estimate requirement would impose on advisers and brokers and the
accuracy of the information that would be reported to
clients.-[49]-
The disclosure that the Commission is proposing to require
is designed to alert a client that the adviser receives soft
dollar services from directing client commissions, and provide
some indication of the extent to which the client benefits from
that direction. The commission rate information, including the
commission rates of execution-only brokers, may provide valuable
information on the costs of soft dollar arrangements and may
render valuation estimates unnecessary. If additional
information is desired, the client can request it from the
adviser.
Comment is requested whether the commission price and fair
market value of particular soft dollar services, or the soft
dollar services obtained from a broker in the aggregate, should
be required in the annual report. Commenters favoring inclusion
of this information should discuss how the price and value of
proprietary soft dollar services should be determined.
D. Client-Directed Brokerage
Many clients of investment advisers instruct their advisers
to direct some or all of their transactions to a particular
broker or brokers. A client may direct its brokerage, among
other reasons, to obtain services for its own benefit or because
of a pre-existing relationship with the broker.
In addition to disclosing the percentages of an adviser's
total commissions that are directed to execution-only and
research brokers, the proposed annual report would be required to
disclose the percentage of commissions that is directed by
clients.-[50]- Client restrictions on an adviser's brokerage
discretion may be of interest to other clients of the adviser
because they may cause a larger proportion of the brokerage of
the other clients to be used to obtain soft dollar services for
the adviser. Information on client-directed brokerage,
therefore, may be useful to clients in determining the amount of
brokerage available to the adviser to purchase soft dollar
services. Comment is requested whether the proposed disclosure
of the percentage of client-directed brokerage would be useful,
and whether the Commission should require that the data be
accompanied by disclosure explaining its usefulness.
E. Principal Transactions
Proposed Form ADV-B would require an adviser to include in
the commission and commission rate in the table mark-ups and
mark-downs paid in connection with principal transactions if the
amounts of these mark-ups or mark-downs are included in the
-[49]- In proposing rule 28e2-1, the Commission proposed that
the fair value of non-research services be disclosed,
and requested comment on the feasibility and
desirability of requiring disclosure of specific dollar
amounts of brokerage commissions paid to receive
research services. Commenters asserted that it would
be impracticable to value soft dollar services or to
separate commissions into their research and execution
components. See Release 10569, supra note 41.
-[50]- Item 4 of proposed Form ADV-B.
-------------------- BEGINNING OF PAGE #16 -------------------
confirmations of the transactions required under rule 10b-10
under the 1934 Act. Rule 10b-10 requires that a dealer include
transaction cost data in confirmations of (1) riskless principal
transactions in equity securities if the dealer is not a market
maker in the securities, and (2) transactions in a listed equity
securities and certain Nasdaq securities.-[51]-
Proposed Form ADV-B would not require disclosure of
information about other principal transactions or the mark-ups,
mark-downs or spreads paid on these transactions. It may be
difficult to accurately determine transaction costs associated
with these principal transactions. Furthermore, disclosure about
adviser direction of principal transactions may not be necessary,
as soft dollar arrangements involving principal transactions may
be less common than those involving agency transactions because
principal transactions are not afforded the safe harbor provided
by Section 28(e).-[52]-
Comment is requested whether the annual report should
include information on all principal transactions, and, if so,
how the associated costs should be determined. Comment is also
requested whether disclosure requirements that apply primarily to
agency transactions would cause more transactions to be executed
on a principal basis.
The proposal would require disclosure of the brokers to
which the greatest amounts of commissions had been directed.
Alternatively, the obligation to disclose information about a
broker could be based on the dollar amount of transactions, both
principal and agency, directed to the broker. The resulting
disclosure might be more useful to clients in assessing any
relationship that may exist between the adviser's use of
principal transactions and its receipt of soft dollar services.
Comment is requested whether the basis for requiring a broker to
be listed in the annual report should be the dollar amount of
transactions directed to the broker, rather than the amount of
commissions.
F. Client-Specific Information
The proposed amendments would not require that an adviser
provide each client with information about how that client's
brokerage was directed ("client-specific information"). Client-
specific information could assist a client in comparing the use
-[51]- Paragraph (a)(8) of rule 10b-10 [17 CFR 10b-10(a)(8)].
-[52]- The safe harbor does not encompass soft dollar
arrangements under which research services are acquired
as a result of principal transactions. See note 10
supra. Notwithstanding the lack of availability of the
safe harbor, the Commission understands that full
service brokers sometimes provide research and other
services based, at least in part, on principal
transactions. If an adviser were required to list a
broker in its annual report because the broker is used
frequently for agency transactions, the adviser would
be required to take all of the soft dollar services
obtained from the broker into account in responding to
the report's requirement to list the services obtained,
even if some of the services could be deemed to be
received as a result of principal transactions not
within the scope of the proposed amendments.
Instruction 7 to Item 2 of proposed Form ADV-B.
-------------------- BEGINNING OF PAGE #17 -------------------
of its brokerage with that of the adviser's other clients.-[53]-
The benefits of a requirement to disclose client-specific
information, however, may be outweighed by the time and cost to
advisers of preparing separate reports for every client. This
cost would likely be passed on to advisory clients. Furthermore,
advisory clients currently receive or have access to
confirmations of their transactions that disclose the identities
of the brokers used and the amounts of commissions charged.-[54]-
Comment is requested whether client-specific information should
be required in the annual report and, if so, what information
should be required.-[55]-
G. Delivery and Filing
Reports on Form ADV-B would be prepared on an annual basis
and would report on brokerage directed during the adviser's most
recently completed fiscal year.-[56]- The report would be
required to be filed with the Commission and delivered to clients
no later than sixty days after the end of the fiscal year, and
delivered to prospective clients no later than the time that an
advisory contract is entered into.-[57]-
-[53]- To the extent differences between the manner in which
an adviser uses a particular client's brokerage and the
brokerage of the adviser's other clients is caused by
client-directed brokerage, the requirement of the
proposal to disclose the percentage of client-directed
brokerage might render client-specific information
unnecessary. See Section II.D supra.
-[54]- See rule 10b-10 under the 1934 Act [17 CFR 240.10b-10]
(requiring broker-dealers to send immediate
confirmations of transactions to their customers). The
confirmations, or quarterly statements containing all
of the information required in the confirmations, must
be sent to the holder of the account, rather than any
fiduciary managing the account. See Securities
Exchange Act Rel. No. 34962 (Nov. 10, 1994) [59 FR
59612 (Nov. 17, 1994)] at II.A.2.
-[55]- As noted above, an adviser to an investment company is
required to provide information about its soft dollar
arrangements to the company's board of directors. See
note 24 supra. The information provided by the adviser
generally should include specific information about the
adviser's use of the investment company's brokerage.
The proposed annual report would supplement this fund-
specific information.
-[56]- Paragraph (a) of proposed rule 204-4; General
Instructions 1 and 5 to proposed Form ADV-B. The table
in the annual report would be required to disclose
commissions paid during the adviser's most recently
completed fiscal year even if soft dollar services paid
for with those commissions had been or will be received
during another fiscal year. Conversely, disclosure of
soft dollar services received during a fiscal year
would be required even if commissions were or will be
directed to pay for those services during another
fiscal year. General Instruction 5 to proposed Form
ADV-B.
-[57]- Paragraphs (a) and (b) of proposed rule 204-4; General
Instructions 3 and 4 to proposed Form ADV-B. Rule 204-
(continued...)
-------------------- BEGINNING OF PAGE #18 -------------------
Because the report would provide information about brokerage
over which the adviser has discretion, the report would be
required to be delivered only to those clients over whose
accounts the adviser has or will have brokerage discretion. An
adviser would be considered to have brokerage discretion over an
account if it (1) had the authority to determine, without
obtaining specific client consent, the brokers to be used or the
commissions paid in connection with any transactions for the
account, or (2) significantly influenced the selection of brokers
by a client and received soft dollar services from a broker
chosen by the client.-[58]- An adviser would not be required to
provide the report to a client that, without the adviser's
influence, directed that a single broker execute its
transactions, or prior to each transaction approved the broker to
be used for the transaction.-[59]- Comment is requested whether
this definition of brokerage discretion is appropriate, and
whether the report should be required to be delivered to clients
over whose accounts the adviser does not have brokerage
discretion.
The Commission is proposing that the report be prepared on
an annual basis. More frequent reporting would be more costly
and may not be necessary for clients to monitor an adviser's
brokerage direction practices. Furthermore, an annual report may
provide a more representative sample of an adviser's brokerage
practices. Comment is requested whether the report should be
required to be prepared more frequently than annually, such as
-[57]-(...continued)
3 under the Advisers Act, which generally requires
advisers to furnish a disclosure brochure to
prospective clients no later than 48 hours prior to the
time that the advisory contract is entered into,
permits the brochure to be delivered at the time that
the contract is entered into if the contract can be
terminated without penalty within five business days.
Paragraph (b)(1) of rule 204-3 [17 CFR 275.204-
3(b)(1)]. Proposed rule 204-4 would not similarly
differentiate between providing the annual report
before or at the time that the contract is entered
into. Generally, however, the determination of when a
contract is entered into would be the same for the
purposes of both rules.
-[58]- Paragraph (c)(1) of proposed rule 204-4; General
Instruction 2 to proposed Form ADV-B. An adviser would
not be deemed to have brokerage discretion over an
account if substantially all of the client's
transactions were directed to a broker that was
compensated for executing the transactions based upon a
percentage of the assets managed by the adviser, such
as in a "wrap fee" program, even if the adviser could
in certain circumstances direct the client's
transactions to other brokers.
-[59]- An adviser would be required to deliver the annual
report to a client if the adviser had discretion over
any of the client's brokerage, even if some or most of
the client's brokerage was directed by the client.
Delivery of the annual report also would be required if
the adviser had the authority to select brokers for
particular transactions from a list previously approved
by the client.
-------------------- BEGINNING OF PAGE #19 -------------------
quarterly.-[60]-
H. Goldman/Morgan Proposal
The Goldman/Morgan Proposal differs from the Commission's
proposal in a number of respects. The Goldman/Morgan Proposal
would, among other things, require quarterly rather than annual
reporting, require disclosure of the commission price and value
of specific third-party soft dollar services, and require
disclosure of certain client-specific information. The
Commission has requested comment on these elements of the
Goldman/Morgan Proposal separately in this Release. The
Commission also requests comment whether the Goldman/Morgan
Proposal generally would be preferable to the Commission's
proposal.
III. DISCLOSURE BY BROKERS PROVIDING SOFT DOLLAR SERVICES
The amendments being proposed in this Release would require
disclosure by advisers that receive soft dollar services from
brokers. In a letter to the staff, Autranet, Inc. ("Autranet"),
a broker providing third-party soft dollar services to advisers,
proposed an entirely different approach that would impose certain
recordkeeping and disclosure requirements on brokers providing
third-party soft dollar services to ensure that the services were
provided within the safe harbor of Section 28(e) of the Exchange
Act.-[61]- Under the Autranet proposal, these brokers would be
required to demonstrate that they incurred a legal obligation to
provide soft dollar services to an adviser. This obligation
could be demonstrated either by a contract that indicates the
-[60]- The Morgan/Goldman Proposal would have required
quarterly reporting.
-[61]- Autranet also has proposed that the Commission prohibit
understandings that commit an adviser to a
predetermined amount of commissions in exchange for
soft dollar services. The Commission requests comment
on the feasibility of this proposal. In particular,
the Commission requests comment whether prohibiting a
stated commission ratio in exchange for soft dollar
services will deter the negotiation of commission rates
and cause advisers that are less sophisticated or
influential to pay higher commissions.
In addition, Autranet proposed that the Commission ensure
that an independent research originator make its services
available to a number of brokers and not enter into
exclusive agreements. For instance, under "bump up" or
bonus arrangements a vendor will assign a cash value to its
product and offer it to the public at large for a lower
price than charged to a broker providing the product
pursuant to a soft dollar arrangement. In other
arrangements, a vendor will tie the availability of its
product to a single affiliated or unaffiliated broker, thus
causing all trades to go through that broker in exchange for
the service. Autranet believes that by eliminating
commission commitments and exclusivity arrangements, a
client can be better assured that the adviser obtained the
best execution of the client's order. The Commission
requests comment on the feasibility of a prohibition on
exclusivity and bonus arrangements and whether such a
proposal would accomplish the objective of assuring best
execution. The Commission also has forwarded these
proposals to the NASD for its consideration under its
authority to promulgate just and equitable principles of
trade.
-------------------- BEGINNING OF PAGE #20 -------------------
broker's financial obligation to purchase the soft dollar
services from an independent research originator, or by an
invoice showing the broker's payment for the services for those
soft dollar services not typically the subject of a contract.
In addition, Autranet proposes that third-party soft dollar
brokers be required to provide a description of the soft dollar
services provided in an arrangement and specify how the product
assists an adviser in its investment decisions. A broker would
be required to make this description available to the managed
account upon request and provide the managed account a quarterly
report showing the cost of the soft dollar service. For products
having a mixed-use, Autranet proposes that the broker providing
such a product obtain from the adviser a description of the
adviser's use of the product and the adviser's allocation between
the research and non-research functions of the product.
Autranet proposes that these descriptions be reflected in an
annual report that third-party soft dollar brokers would file
with the Commission and provide to the advisers receiving soft
dollar services and to the clients of those advisers whose
commissions were used to obtain the soft dollar services.
Autranet proposes that the report include (1) a disclosure
statement describing the business of the third party broker; (2)
a financial summary, quantifying on an aggregate basis the value
by category and, if necessary, sub-category, of the soft dollar
services provided; (3) a compliance report, demonstrating that
the soft dollar services were in compliance with the requirements
set forth above and within the safe harbor of Section 28(e); and
(4) an independent auditor's report. Autranet believes that such
a reporting requirement would not be costly to third-party
brokers because the information required is readily available and
the reporting requirements should reflect compliance procedures
already established by third-party brokers providing soft dollar
services.
The Commission requests comment on whether some or all of
the Autranet proposals would be practical additions to the
disclosure currently required and proposed of advisers. In
particular, the Commission requests comment on the costs
associated with this disclosure approach and the ease with which
this information could be obtained by brokers and provided to
advisers and their clients. In addition, the Commission requests
comment on the extent to which full service brokers providing
proprietary soft dollar services could or should be subject to
any of the reporting requirements proposed by Autranet.
IV. GENERAL REQUEST FOR COMMENTS
Any interested persons wishing to submit written comments on
the proposals that are the subject of this Release, to suggest
additional changes, or to submit comments on other matters that
might have an effect on the proposals that are contained in this
Release, are requested to do so.
V. COST/BENEFIT ANALYSIS
The rule and form proposed today are intended to provide
material information to clients and prospective clients of
investment advisers that can be used to evaluate an adviser's
brokerage direction and soft dollar practices. The proposals
would enable an advisory client to better assess whether its
adviser is directing its brokerage in accordance with its best
interests, and whether the advisory fee it pays is appropriate in
light of the services provided and costs incurred directly by the
adviser.
Adoption of the proposal would impose some additional costs
on advisers required to prepare the report and deliver it to
clients. The Commission believes, however, that the proposals
appropriately balance the need for additional disclosure with the
costs of providing that disclosure. The information that would
-------------------- BEGINNING OF PAGE #21 -------------------
be required by the proposal should readily be determinable by an
adviser. A number of alternatives that would make the disclosure
requirements more burdensome, such as requiring advisers to
disclose the value of soft dollar services received or report on
the use of each client's brokerage, are not being proposed.
Furthermore, because the report would need to be prepared and
delivered only annually, the costs of preparing and delivering
the report should be minimized. In short, the Commission
believes that the costs of the proposals would be outweighed by
the benefits to advisory clients in receiving more useful
information about their advisers' direction of client brokerage.
VI. SUMMARY OF INITIAL REGULATORY FLEXIBILITY ANALYSIS
The Commission has prepared an Initial Regulatory
Flexibility Analysis in accordance with 5 U.S.C. 603 regarding
the proposed amendments. The analysis notes that the rule and
form proposed in this Release are intended to provide investment
advisory clients for whom the adviser selects brokers to execute
client transactions with information about the services the
adviser receives from those brokers and the commissions charged
by those brokers. Other aggregate cost-benefit information
reflected in the "Cost/Benefit Analysis" section of this Release
also is reflected in the analysis. A copy of the Initial
Regulatory Flexibility Analysis may be obtained by contacting
Jana M. Cayne, Securities and Exchange Commission, 450 Fifth
Street, N.W., Mail Stop 10-6, Washington, D.C. 20549.
VII. STATUTORY AUTHORITY
The Commission is proposing rule 204-4 and Form ADV-B under
the authority set forth in Sections 204, 206(4) and 211(a) of the
Advisers Act [15 U.S.C. 80b-4, 80b-6(4) and 80b-11(a)] and
Section 28(e)(2) of the 1934 Act [15 U.S.C. 78bb(e)(2)].
TEXT OF PROPOSED RULE AND FORM AMENDMENTS
List of Subjects in 17 CFR Parts 275 and 279
Investment advisers, Reporting and recordkeeping requirements
For the reasons set out in the preamble, title 17, chapter
II of the Code of Federal Regulations is proposed to be amended
as follows.
PART 275 - RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
1. The authority citation for Part 275 is amended by adding
the following citation:
AUTHORITY: 15 U.S.C. 80b-3, 80b-4, 80b-6A, 80b-11, unless
otherwise noted.
* * * * *
Section 275.204-4 is also issued under 15 U.S.C. 78bb(e)(2).
2. By adding 275.204-4 to read as follows:
275.204-4 Annual report on brokerage practices.
(a) Each investment adviser, registered or required to be
registered under Section 203 of the Act on the last day of its
most recently completed fiscal year, that exercised brokerage
discretion over the account of any client during that fiscal year
and obtained services other than execution services from a broker
to which it directed client brokerage during that fiscal year
shall file a report on Form ADV-B with the Commission no later
than 60 days after the end of that fiscal year, unless the
investment adviser's registration was withdrawn, cancelled or
revoked after the end of the fiscal year.
(b) An investment adviser required to file a report on Form
ADV-B pursuant to paragraph (a) of this section shall furnish
such report for its most recently completed fiscal year:
(1) No later than 60 days after the end of each fiscal year,
to each advisory client over whose account the investment adviser
exercises brokerage discretion; and
(2) No later than the time that a written or oral investment
advisory contract is entered into, to each new or prospective
advisory client over whose account the investment adviser will or
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proposes to exercise brokerage discretion.
(c) For purposes of this section:
(1)(i) An investment adviser exercises "brokerage
discretion" over a client's account if it:
(A) Has authority to determine, without obtaining specific
client consent, the broker to be used or the commission rates
paid in connection with any transaction of the client; or
(B) Significantly influences the selection of brokers by the
client and receives services other than execution services from a
broker chosen by the client.
(ii) An investment adviser does not exercise brokerage
discretion over a client's account if substantially all of the
client's transactions were directed to a broker that was
compensated for executing such transactions solely based upon a
specified percentage of the assets managed by the investment
adviser; and
(2) Execution services mean those services set forth in
paragraph (e)(3)(C) of Section 28 of the Securities Exchange Act
of 1934 (15 U.S.C. 78bb(e)(3)(C)).
Part 279 - FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF
1940
3. The authority citation for Part 279 is amended by adding
the following citation:
AUTHORITY: The Investment Advisers Act of 1940, 15 U.S.C.
80b-1, et seq.
Section 275.204-4 is also issued under 15 U.S.C. 78bb(e)(2).
4. By adding 279.9 and Form ADV-B to read as follows:
279.9. Form ADV-B, annual report on investment adviser's
brokerage direction practices.
This form shall be filed annually by an investment adviser,
registered or required to be registered under the Investment
Advisers Act of 1940, that has the authority to select brokers to
execute the transactions of any client and that obtains services
other than execution from a broker to which it directs client
brokerage.
Note: Form ADV-B is attached as Appendix 1 to this document.
The Form will not appear in the Code of Federal Regulations.
By the Commission.
Jonathan G. Katz
Secretary
February 14, 1995
-------------------- BEGINNING OF PAGE #32 -------------------
Appendix 1
OMB APPROVAL
OMB Number:
Expires:
Estimated average burden
hours per response:
U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM ADV-B
ANNUAL REPORT ON BROKERAGE PRACTICES
FOR REGISTERED INVESTMENT ADVISERS
HAVING DISCRETION OVER CLIENT BROKERAGE
Applicant: SEC File Number:
Date:
801-
MM/DD/YY
General Instructions for Preparing and Filing Form ADV-B
1. Applicability of Form Requirement. A report on Form ADV-B
must be prepared and filed by every investment adviser that
(i) was registered or required to be registered under the
Investment Advisers Act of 1940 on the last day of its most
recently completed fiscal year (unless the adviser's
registration has since been withdrawn, cancelled or
revoked), (ii) exercised "brokerage discretion" over the
account of any advisory client during that fiscal year, and
(iii) obtained services other than "execution services" from
a broker to which it directed client brokerage during that
fiscal year.
2. Definitions
Brokerage Discretion. An investment adviser exercises
brokerage discretion over a client's account if it (i) has
the authority to determine, without obtaining specific
client consent, the broker to be used or the commission
rates paid in connection with any transaction of the client,
or (ii) significantly influences the selection of brokers by
the client and receives services other than execution
services from a broker chosen by the client. An investment
adviser does not have discretion over a client's account,
however, if substantially all of the client's transactions
were directed to a broker that was compensated for executing
such transactions solely based upon a specified percentage
of the assets managed by the adviser, even if the adviser
has the discretion to direct certain of the client's
transactions to other brokers.
Execution Services. Execution services mean those services
described in Section 28(e)(2)(C) of the Securities Exchange
Act of 1934, i.e., effecting securities transactions and
performing functions incidental thereto or required in
-------------------- BEGINNING OF PAGE #33 -------------------
connection therewith by rules of the Securities and Exchange
Commission or a self-regulatory organization.
3. Format and Filing of Report. The report required by this
form should be prepared as a separate document, not on
copies of this Form. The report shall be filed in
triplicate with the Securities and Exchange Commission, 450
Fifth Street N.W., Washington, D.C. 20549. Each copy of the
report filed with the Commission should be attached to a
completed copy of this page, although only one such copy
need be manually executed. The report shall be filed no
later than 60 days after the end of the adviser's fiscal
year.
EXECUTION: The undersigned represents that he or she has
executed this form on behalf of, and with the authority of, said
investment adviser. The undersigned and the investment adviser
represent that the information and statements contained herein,
including exhibits attached hereto and other information filed
herewith, all of which are made a part hereof, are current, true,
and complete.
Dated the __________________ day of
____________________________________________, 19__
_________________________________________________________________
_____________________
(NAME OF REGISTRANT)
By:______________________________________________________________
_____________________
(SIGNATURE AND TITLE)
4. Delivery
Existing Clients. Rule 204-4 under the Investment Advisers
Act of 1940 requires that the report be furnished no later
than 60 days after the end of the investment adviser's most
recently completed fiscal year to each advisory client over
whose account the adviser exercises brokerage discretion (as
defined in Instruction 2 above).
Prospective Clients. Rule 204-4 also requires that the
report be furnished no later than the time that a written or
oral investment advisory contract is entered into to each
new or prospective advisory client over whose account the
adviser will or proposes to exercise brokerage discretion.
5. Period of Required Data. An investment adviser must provide
the requested information for its most recently completed
fiscal year. Brokerage commissions directed or services
received during a fiscal year should be included in the
table, even if the services corresponding to commissions
directed during the fiscal year were or will be received
during another fiscal year, or the commissions corresponding
to services received during the fiscal year were or will be
directed during another fiscal year.
6. Additional Information. An investment adviser may, in
addition to providing the required information, provide
other information, including additional data and
explanations of the required information, about its
brokerage practices in its response to this Form.
-------------------- BEGINNING OF PAGE #34 -------------------
Information Required in Annual Report
Item 1. General Description of Report
In an introduction to the report:
(a) explain that the report contains information about the
adviser's practices in selecting brokers to execute
transactions for its investment advisory clients that can be
used to evaluate whether the adviser directs client
transactions consistent with the best interests of its
clients;
(b) explain that the information contained in the report is
provided on a firm-wide basis, that the report does not
include specific information about the brokerage of any
particular client or the extent to which services obtained
are used for the benefit of any particular client, and that
clients should refer to the confirmations or quarterly
account statements provided by their brokers or contact the
adviser for information about the brokers used to execute
their transactions;
(c) explain, if applicable, that the report does not include
information about many transactions executed on a
"principal" basis, that, in principal transactions,
transaction costs typically are included in the price of the
securities purchased or sold and are not charged as separate
commissions, and that transactions in certain types of
securities typically are executed on a principal basis; and
(d) provide an address or phone number at which a client can
contact the adviser to request more information.
Item 2. Information Regarding the Twenty Most Frequently Used
Brokers
Using the captions and tabular format illustrated below,
provide the required information for the twenty brokers (other
than "execution-only" brokers as defined in Item 3) to which the
investment adviser directed the greatest amount of client
commissions. If no or fewer than twenty such brokers were used,
state either "no brokers used that provided services other than
execution" after the title or "no additional brokers used" after
the last broker listed.
The Twenty Brokers to which the Greatest Amounts of Client
Commissions were Directed
----------------------------------------------------------------
|Aggregate Amount | Commissions Paid |Average
Name of|of Discretionary | to Broker (as a |Commission
Broker |Commissions Paid to| percentage of adviser's|Rate (in
|Broker (in dollars)| discretionary |cents/share)
| | commissions) |
----------------------------------------------------------------
Description of |
Services |
Obtained (other |
than execution |
services) |
----------------
-------------------- BEGINNING OF PAGE #35 -------------------
Instructions:
1. For the purposes of this Form, brokers include broker-dealers
registered under the Securities Exchange Act of 1934, banks, and,
as set forth in Item 3, automated trading systems.
2. "Discretionary commissions" are those commissions, mark-ups
and mark-downs that are disclosed on the transaction
confirmations required under rule 10b-10 under the Securities
Exchange Act of 1934 and that are paid in connection with
transactions for which the investment adviser had the authority
to determine, without obtaining specific client consent, the
broker or dealer to be used or the commission rates paid.
3. Commissions include sales loads paid in connection with
transactions in investment company shares, although sales loads
should not be considered in calculating the average commission
rate. If the adviser directed transactions in investment company
shares to a broker other than the principal underwriter of the
investment company, that broker, rather than the principal
underwriter, should be considered to have executed the
transaction.
4. For purposes of this Form, commissions do not include fees
for brokerage services that are based upon a specified percentage
of the assets managed (i.e., fees paid under "wrap fee"
programs).
5. Calculate average commission rates on a "share-weighted"
basis (i.e., by dividing the total amount of client commissions
that the investment adviser directed to the broker by the total
number of shares, exclusive of investment company shares,
purchased or sold by the broker for the adviser's clients).
6. For the purposes of determining commission amounts and
average commission rates, convert any commission charged in
foreign currency to dollars (and cents per share). The
investment adviser may use any reasonable means and times for
determining the applicable exchange rate as long as those means
and times are used on a consistent basis.
7. Under "Description of Services Obtained," products or
services obtained by the investment adviser from each broker,
including computer hardware, software, databases, and on-line
services, publications available by subscription, and services
falling outside the scope of Section 28(e) of the Securities
Exchange Act of 1934, generally should be identified separately
and specifically. Research reports and contacts with securities
analysts or professionals, however, may be described generally by
the following terms: (i) analyses and reports on specific
securities, issuers, or industries, (ii) general political or
economic analyses or reports, or (iii) contacts with securities
analysts. The party that produced a specifically identified
product or service should also be identified unless the
producer's name is evident from the name of the product or
service. An adviser should report all products or services
received from a broker, even if some of the services could be
deemed to have been received as a result of principal
transactions the costs of which are not required to be reported
in the table.
-------------------- BEGINNING OF PAGE #36 -------------------
Item 3. Information Regarding Three Most Frequently Used
Execution-Only Brokers
Using the captions specified under Item 2 (except
"Description of Services Obtained"), provide a table titled "The
Three Execution-only Brokers to which the Greatest Amounts of
Client Commissions were Directed" that includes the required
information for the three execution-only brokers to which the
investment adviser directed the greatest amount of client
commissions. If no or fewer than three execution-only brokers
were used, state either "no execution-only brokers used" after
the title or "no additional execution-only brokers used" after
the last broker listed.
Instruction:
For the purposes of this Item, a broker should be considered an
execution-only broker if substantially all of the services that
it provides to the adviser are execution services (see the
definition in Instruction 2 of the General Instructions). An
automated trading system should be considered an execution-only
broker if substantially all of the services received by the
adviser in connection with using the system are execution
services and if a fee is charged for using the system, regardless
of the basis for the fee (e.g., a flat usage fee or transaction-
based charges).
Item 4. Information Regarding Brokerage Business Directed by
Clients
Provide the following information under the following
captions:
Percentage of Total Commissions Directed to Brokers Providing
Research and Other Services in Addition to Execution:
Percentage of Total Commissions Directed to Execution-only
Brokers:
Percentage of Total Commissions Directed by Clients:
Instruction:
For the purposes of this Item, commissions directed by clients
are those commissions paid by accounts managed by the adviser
that were directed pursuant to client requests or instructions.
Total commissions equal the sum of the adviser's discretionary
commissions, as defined in Item 2, and the commissions directed
by clients.