SEC Publishes Guidance On 'Soft Dollar' Safe Harbour

by Glen Shapiro, LawAndTax-News.com, New York

17 July 2006

The US Securities and Exchange Commission last week 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 the Securities Exchange Act of 1934.

Section 28(e) of the 1934 Securities Act 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, and states that eligible research services are limited to advice, analyses, and reports under Section 28(e). According to the SEC guidance, 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.

Eligible brokerage services are revealed to include 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 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, it 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.

Arrangements whereby money managers obtain brokerage and research services from broker-dealers and other research providers are also addressed, and 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 Commission will receive and consider additional comment on these client commission arrangements given evolving developments in the industry, and may supplement the guidance in the Interpretive Release if it determines that further guidance in this area is appropriate.

The 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.

Recommended