Please refer to: J. David Griswold
Direct Line: 253-596-5381
Legal Dept Fax: 253-596-3284

June 13, 2000


Mr. Jonathan G. Katz
U.S. Securities And Exchange Commission
450 - 5th Street, N.W.
Washington, D.C. 20549-0609

RE: File No. S7-10-00

Proposed Changes to Form ADV

Release IA-1862, 34-42620

Dear Mr. Katz:

Frank Russell Securities, Inc. is pleased to comment on the U.S. Securities and Exchange Commission's ("Commission") Proposed Amendments to Form ADV, which the Commission has noted for comment in connection with the proposal for Electronic Filing by Investment Advisers. In particular, we would like to comment on the proposed amendments to Item 11 of Part 2.A with respect to Brokerage Practices.

Soft Dollars

With regard to the specific changes proposed, we applaud the Commission's decision to include both proprietary and third party research in the required disclosure in Part 1.A of Item 11. Earlier proposals drew an unwarranted distinction between proprietary and third party research. If an Adviser faces a potential conflict in allocating client trades when it chooses a Broker that provides research benefits, then from the standpoint of the Adviser, that conflict exists whether or not the research is generated in-house at the Broker, or is purchased by the Broker from third parties.

We would note, however, that the disclosures required in A.1.c and A.1.d of Item 11 are largely redundant, and that the overall level of detail required is significant in relation to other Items in the Form given that soft dollar practices enjoy a Congressionally mandated safe harbor in Section 28(e) of the Securities Exchange Act of 1934.

Directed Brokerage

We believe that the term "Directed Brokerage" as used in A.3.a and A.3.b of Item 11 should be defined. As used in the current proposal, the term is potentially confusing to Advisers, Brokers and their clients alike. First, some practices covered by A.3.a and A.3.b appear to be already covered elsewhere in Item 11, rendering the disclosure at key points duplicative and confusing. Second, A.3.a and A.3.b appear to cover certain activities that neither the institutional investing community nor the governmental or industry groups that have examined soft dollars in recent years would consider to be legitimate directed brokerage activities. Any confusion caused by the language of A.3.a and A.3.b of proposed Item 11 will likely show up as unclear disclosure in actual filings.

Duplicative and Confusing Disclosure. By way of example, A.3.a requires disclosure of affiliations or other economic relationships between the Adviser and the Broker that create material conflicts of interest. Yet where that material interest is a client referral relationship, the disclosure is already required by A.2. In that sense, A.2 presents little more than a specific application of the general principle set forth in A.3.a.

Conversely, A.3.b requires disclosure of risks that arise when an Adviser permits a client to direct brokerage. Yet A.4 already requires comparable disclosure where the client receives cash rebates or other benefits with economic value. Here, A.4 appears to present the more general case.1 Ironically, A.3.b presumes that brokerage relationships where the client is the direct beneficiary present additional risks, whereas A.4 stops just short of promoting functionally equivalent relationships as desirable. The principal distinction between A.3.b and A.4 appears to be based upon whose idea it was to use a particular Broker. We do not believe this to be a meaningful distinction in practice.

Inconsistency with Institutional Definitions and Practices. Institutional Advisers and Brokers and their respective clients are accustomed to using the more restrictive definition of client directed brokerage arrangements provided by AIMR2 and the Department of Labor Advisory Council on Employee Welfare and Benefit Plans.3 As understood by the institutional investing community, directed brokerage describes arrangements where the client requests or requires that the Adviser use a particular Broker or Brokers. Describing the practices described in A.3.a of Item 11 as directed brokerage therefore cuts against how that term is generally understood, especially when the investment adviser requires that a Broker be used. In such cases, the client cannot be said to be directing the investment adviser's use of a Broker in any meaningful sense. It may be that some Advisers have required that trades be executed through Brokers and have chosen to characterize this requirement as resulting from direction by the client in their client agreements. We agree that this practice presents clear and obvious conflicts of interest which must, at minimum, be disclosed. We do not agree that this practice should be permitted to be described as directed brokerage.

We object to the implication contained in A.3.b that client directed brokerage necessarily presents a risk to achieving best execution. Institutional investors are often fiduciaries in their own right and the client direction is customarily qualified by the requirement that the Adviser direct trades only to the extent best execution can be obtained. Put another way, much of what the institutional investing community considers to be legitimate directed brokerage practices is already covered in the proposed Form under the rubric "commission recapture" and the added disclosure required by A.3.b is potentially confusing.

Separately, we believe that the disclosure required under A.3.b of Item 11, while not harmful, is probably unnecessary. Allowing a client to direct trading activity generally imposes additional operational burdens on an Adviser, especially where the Adviser has been obligated to do so under its client agreement and failing to direct might result in liability. The Adviser will therefore likely inform the client of any perceived concerns that client directed brokerage may present. Any Adviser concerned about its residual liability for failing to obtain best execution where a client directs brokerage will likely put its warning in writing in the advisory agreement or otherwise. The more likely it is that the Broker chosen by the client lacks the ability to obtain best execution across a wide variety of trading activity, the more likely it is that the Adviser will give and document the disclaimer. Using the Form to protect the client from its own decisions is unnecessary where it is already in the Adviser's self interest to do so. It would be far better to permit each Adviser to determine the extent to which a client directed brokerage disclaimer is given and the manner in which it is delivered. We note that the overwhelming majority of retail clients have no interest in directing trading activity and the added bulk resulting from the disclosure will make it much less likely that the brochure will be read and understood, and much more likely that the more immediately relevant disclosure will be overlooked.

Recommended Changes. We recommend that the instructions to Item 11 include a definition of directed brokerage that is crafted to be consistent with industry best practices as evidenced by the institutional investing community. In particular, the definition should be drafted narrowly to be synonymous with client directed brokerage and should explicitly recognize commission recapture as a variant of a client directed brokerage and not something different in kind. An alternative would be to drop the requirement for disclosure of practices covered by A.3.a and A.4 altogether. To address situations where an Adviser requires the use of a particular Broker, we strongly urge that the Commission amend Item 11 to include a new section covering mandatory brokerage practices. Mandatory brokerage could be understood to include any situation where the Adviser either (i) requires that a Broker be used or (ii) conditions the level of fees or services upon the selection of the Broker. Not only would this preserve the definition of directed brokerage as it is commonly understood, but it would have the added benefit of discouraging registrants from characterizing such mandatory arrangements as client directed when exactly the opposite has occurred.


J. David Griswold
Associate General Counsel

cc: Karl J. Ege, Esq.
Mr. H Paul Reynolds

1 We believe that the practice of clients directing trading activity to brokers due to family relationships described in the proposing release is not commonplace, and in any event does not represent a significant potential for abuse by the Adviser except in rare instances where the Adviser and Broker are both affiliated and related to the client.
2 AIMR defines a client directed brokerage arrangement to mean an arrangement whereby a Client directs that trades for its account be executed through a specific Broker in exchange for which the Client receives a benefit in addition to execution services. (AIMR Soft Dollar Standards, May 17, 1998)
3 The Department of Labor defines directed brokerage to mean when plan sponsors direct investment managers to execute a portion of their trades through a selected brokerage firm to the extent the brokerage firm is competitive in price and trade execution. The brokerage firm then rebates a portion of the commissions to the pension plan. The pension plan can be rebated in cash or have the brokerage firm pay certain administrative expenses of ERISA-covered pension plans. (Report of the Working Group on Soft Dollars/Commission Recapture, November 13, 1997)