Face Off

FACE OFF
The Securities Exchange Act of 1934 was amended in 1975 by the addition of Section
28(e). Section 28(e) defines soft dollars as “commissions paid-up above the fully-
negotiated costs of brokerage execution”.
The recent publication of the SEC’s proposed amendments to Form ADV includes a
section which proposes changes in disclosure requirements relating to institutional
brokerage arrangements, and changes in the disclosure of potential conflicts of interest
arising out of such brokerage arrangements. 1
On June 4, 2008 Traders Magazine published an article written by Peter Chapman

titled, Investors Face Off Against Intermediaries In Soft Dollar Debate. 2 The
article discusses very interesting differences of opinion, on the subject of institutional
soft dollar disclosures, between groups who represent institutional investors and groups
who represent financial intermediaries. The Traders Magazine article compares
statements made in comment letters filed with the SEC by senior representatives of
these groups. The groups who represent investors seem motivated by their fiduciary
obligations, while the groups who represent financial intermediaries seem to be
motivated primarily by commercial self-interest. In the Traders Magazine article
investors' interests seem to be represented by the Council of Institutional Investors and
the Chartered Financial Analyst Institute Center For Financial Market Integrity. The self-
interests of member organizations and their businesses seems to be represented by the
Securities Industry and Financial Markets Association (the lobbying group for the full-
service brokerage industry) and by the Investment Company Institute (the lobbying
group for the mutual fund industry).
It’s been estimated, by Greenwich Associates and others, that in recent years the total
amount of undisclosed institutional soft dollar brokerage commissions has
been approximately 12 billion dollars per year. 3 If these soft dollars are being used to
purchase valuable investment research which contributes to institutional accounts'
investment performance it wouldn’t seem any fiduciary or client would complain, but
if institutional advisors are using the excess commissions paid-up above the fully-
negotiated costs of execution as quid-pro-quo to buy favors from financial
intermediaries it might be a reasonable cause for concern (favors such as, IPO
allocation and flipping consideration while the lock-up period is still in-force, directed
trading in exchange for intermediaries' help with mutual fund sales [also known as shelf-
space arrangements] late trading privileges, and / or, as some sophisticated observers
1
See, Proposed Amendments to Form ADV (Federal Register publication Volume 73, No.51) Item 12 Brokerage Practices page
13966 > http://www.sec.gov/rules/proposed/2008/ia-2711fr.pdf
2
See, Traders Magazine June 4, 2008 article titled, Investors Face Off Against Intermediaries In Soft Dollar Debate access to the
article is free at> http://www.tradersmagazine.com/news/101037-1.html
3
See, references in footnote number 4 in SEC Comment Letter on proposed amendments to Form ADV posted at >
http://www.scribd.com/doc/2465506/Comment-On-Proposed-Amendments-to-SEC-Form-ADV
Face Off by Bill George June 8, 2008 Page 1 of 3

believe, excess commissions paid-up above the fully-negotiated costs of execution
might also contribute to lavish entertainment intermediaries sometimes use to maintain
relationships, or induce new brokerage relationships, with institutional advisory
complexes’ decision makers. Over time an annual drain of 12 billion dollars can have a
significant negative compounding effect on the investment returns of institutional
clients.
Only through improved guidance and regulatory enforcement of commission disclosure

and transparency can regulators, fiduciaries and clients know how brokerage
commissions are being spent. The bundled undisclosed brokerage arrangements used
by most full-service brokerage firms do not facilitate regulatory review, or
brokerage commission oversight.
After a long study of soft dollar practices in the United Kingdom, the U.K. Financial
Services Authority issued guidelines to improve brokerage commission disclosure and
transparency. 4 Canada and MiFid followed by issuing similar disclosure guidelines for
advisors in their jurisdictions. On July 12, 2006 in a SEC "Sunshine Meeting" it seemed
the commissioners of the SEC were promising guidance on the second necessary part
of the SEC's Commission Guidance Regarding Client Commission Practices Under
Section 28(e) of the Securities Exchange Act of 1934. 5 And a little more than a year
after the July 12, 2006 “Sunshine Meeting” U.S. Senator Charles Schumer (D. NY) sent
a letter to SEC Chairman Cox, reminding the SEC of its promise to issue interpretive
guidance on brokerage commission disclosure and transparency. In the third paragraph
of his letter Senator Schumer said:
“The July 2006 Release was lauded as an excellent first step towards
addressing potential abuses of soft dollar practices, but its goals will
only be fully realized with the necessary disclosure regime in place.
So I was encouraged when, contemporaneously with the July 2006
Release, you publicly agreed to create proposed disclosure rules for
public comment by the end of 2006. Rules on transparency and
disclosure are not only desirable, but necessary, as fund boards and
trustees have requested such guidance to properly discharge their
fiduciary duties. Section 28(e) explicitly provides the SEC with
authority to establish an appropriate disclosure regime for client
commission practices, so these rules are both appropriate and
necessary.” 6
4
See, FSA Policy Statement # 05/09 - Bundled Brokerage and Soft Commission Arrangements, published July 2005
> http://www.fsa.gov.uk/pubs/policy/ps05_09.pdf
5
To hear a webcast of this SEC “Sunshine Meeting” scroll down to the July 12, 2006 at
> http://www.connectlive.com/events/secopenmeetings/2006index.html
6
See the complete text of U.S. Senator Schumer’s July 20, 2007 letter to Chairman Cox at
> http://www.scribd.com/doc/509057/Senator-Schumer-Questions-SEC-Chairman-Cox-072007

It seems reasonable, just as Senator Schumer states, that fiduciaries, trustees, plan
sponsors, fund boards and independent directors of mutual funds require constructive
interpretive guidance on brokerage commission disclosure and transparency in order to
fulfill their responsibilities to institutional investors.
Because Section 28(e) is a somewhat complicated regulation, and because the term
soft dollar brokerage has been misapplied, maligned and abused, if you have further
interest in Section 28(e) and soft dollar brokerage, you might find a document published
at Scribd titled, Tooled by Semantics helpful to understanding the history of soft dollar
brokerage. 7
7
Tooled by Semantics and a Whole Lot of Lobbying by Bill George published 11/10/2007 on Scribd at
> http://www.scribd.com/doc/499729/Tooled-by-Semantics

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FACE OFF

On June 4, 2008 Traders Magazine published an article written by Peter Chapman

Face Off by Bill George June 8, 2008 Page 1 of 3

Only through improved guidance and regulatory enforcement of commission disclosure

Face Off by Bill George June 8, 2008 Page 2 of 3

Face Off by Bill George June 8, 2008 Page 3 of 3

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