U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

SEC Votes to Publish Interpretive Guidance on "Soft Dollars" Safe Harbor and to Propose Amendments to Regulation SHO


Washington, D.C., July 12, 2006 - The Securities and Exchange Commission today voted to publish an Interpretive Release that provides guidance on money managers' use of client commissions to pay for brokerage and research services under the "soft dollars" safe harbor, which is set forth in Section 28(e) of the Securities Exchange Act of 1934. The Commission also voted to propose amendments to Regulation SHO (17 CFR 242.200 et seq.) that would further reduce the number of persistent fails to deliver.

1. Interpretive Release on Client Commission Practices

Section 28(e) provides that a person who exercises investment discretion with respect to an account shall not be deemed to have acted unlawfully or to have breached a fiduciary duty under state or federal law solely by reason of having caused an account to pay more than the lowest available commission if that person determines in good faith that the amount of the commission is reasonable in relation to the value of the brokerage and research services received.

The Interpretive Release articulates that the analysis of "brokerage and research services" under Section 28(e) requires a three-step process: the application of eligibility criteria; the money manager's lawful and appropriate use of the items; and the money manager's good-faith determination that the commissions paid are reasonable in light of the value of the services received.

The Interpretive Release clarifies that money managers may use client commissions to pay only for eligible brokerage and research services. The Interpretive Release states that eligible research services are limited to advice, analyses, and reports under Section 28(e). According to the Interpretive Release, this means that traditional research reports, market data, and other items that satisfy the eligibility criteria of Section 28(e) are eligible for the safe harbor as research, but that computer hardware is not. The Interpretive Release also indicates that mass-marketed publications are not eligible under the safe harbor. The Interpretive Release states that eligible brokerage includes those products and services that relate to the execution of the trade from the point at which the money manager communicates with the broker-dealer for the purpose of transmitting an order for execution, through the point at which funds or securities are delivered or credited to the advised account.

The Interpretive Release also indicates that, in order to operate under the safe harbor, the money manager must use the eligible brokerage and research services in a manner that provides lawful and appropriate assistance. For "mixed-use" items that are partly eligible and partly ineligible, the Interpretive Release states that money manager must make a reasonable allocation of client commissions in accordance with the eligible and ineligible uses of the items. In addition, the Interpretive Release reiterates the statutory requirement that money managers must determine in good faith that the commissions they pay are reasonable in relation to the value of the brokerage and research services that they obtain.

The Interpretive Release also addresses arrangements whereby money managers obtain brokerage and research services from broker-dealers and other research providers. The Interpretive Release states that the safe harbor is available when a money manager does business with a broker-dealer that is involved in "effecting" the money manager's trades and "provides" the research. According to the Release, in order to be "effecting" transactions, the broker-dealer must either execute, clear, or settle the trade, or perform one of four specified functions and allocate the other functions to other broker-dealers. The Interpretive Release also states that Section 28(e) is satisfied, and the safe harbor is available to the money manager, if the broker-dealer that is effecting transactions for the advised accounts is either legally obligated to pay for the research or pays the research preparer directly and takes steps to see that the services to be paid for with client commissions are within Section 28(e). The Interpretive Release states that the Commission will receive and consider additional comment on these client commission arrangements given evolving developments in the industry, and that the Commission may supplement the guidance in the Interpretive Release if it determines that further guidance in this area is appropriate.

The Interpretive Release will be effective upon publication in the Federal Register, but market participants will be able to rely on prior Commission guidance for a period of six months following publication.

2. Proposed Amendments to Regulation SHO

The Commission also voted to approve the issuance of a release proposing amendments to Regulation SHO. The proposed amendments are intended to further reduce the number of persistent fails to deliver, by eliminating the grandfather provision and narrowing the options market maker exception. The proposed amendments also would update the market decline limitation.

Regulation SHO, which became fully effective on Jan. 3, 2005, provides a new regulatory framework governing short sales. Among other things, Regulation SHO imposes close-out requirements to address the issue of fails to deliver certain equity securities. While a majority of trades settle on time, Regulation SHO addresses situations where the level of fails to deliver for certain equity securities are substantial and persistent. These fails to deliver can result from either short sales or long sales.

Regulation SHO has achieved substantial results in reducing fails to deliver. However, some persistent fails to deliver remain. The proposals are intended to reduce the level of fails to deliver attributable to the grandfather provision and the options market maker exception. In particular, the proposed amendments would eliminate the grandfather provision in Rule 203(b)(3)(i) and limit the duration of the options market maker exception in Rule 203(b)(3)(ii) to 13 consecutive settlement days from the date on which the security becomes a threshold security or the options position expires or is liquidated, whichever is later. In addition, the proposal includes a technical amendment that would update the market decline limitation referenced in Rule 200(e)(3).

Comments on the proposed amendments should be received by the Commission within 60 days of publication in the Federal Register.


The full text of the detailed releases concerning these items will be posted to the SEC Web site as soon as possible.

# # #



Modified: 07/12/2006