The Securities and Exchange Commission's revamped guidelines on soft dollars are a disappointment. That's because they do not require disclosure of soft-dollar payments.
Meaningful disclosure is an essential ingredient to successful investment oversight and regulation. But the SEC, which normally requires adequate disclosure, neglected the issue in its final interpretative guidance reaffirming the use of soft dollars, issued July 12.
Soft dollars obscure how commission dollars are spent, make accountability for the money more difficult and give rise to conflicts of interest.
The SEC must commit to issuing rules requiring disclosure of the details of soft-dollar arrangements between money manages and brokerage firms and any other parties involved. Transparency is especially important for pension funds and mutual funds, considering the latter's importance in defined contribution plans, which are becoming the dominant form of employer-sponsored retirement programs.
The commission said in a footnote in its newly released guidelines that it "is considering whether at a later time to propose requirements for disclosure and record keeping of client commission arrangements."
Why wait? Why does this issue require further consideration? It has been bubbling since the mid-'70s; action is needed, not further consideration of some future action. The SEC should impose disclosure rules and standards now.
Most of the scandals and improprieties that have arisen in the corporate, financial and investment communities have come about because of lack of disclosure and transparency.
Since the so-called Section 28e provision was enacted in 1975, following the end of fixed commission rates, soft dollars have been a source of controversy and often abuse. Some 30 years ago, brokerage firms lobbied successfully for adoption of the safe-harbor provision, allowing money managers to pay reasonably more than was justified for trading execution without breaching their fiduciary duty, provided research-related services were obtained from the brokerage firm in return.
This led to abuses, with brokers providing money managers with "research" such as hard-to-get sporting tickets and theater tickets. The SEC soon stepped in with a tighter definition of research service, but abuses still occurred.
Many problems associated with soft dollars could have been ended by providing for full disclosure, even if the practice of directed-commission payment was not ended.
The SEC will have to overcome pressure from brokerage firms, some money managers and even some pension fund executives seeking to minimize disclosure of the soft-dollar arrangements.
But the U.K. Financial Services Authority rule that took effect July 1 requiring unbundling of execution and research cost could serve as a model for SEC-mandated disclosure and likely will add to pressure for the SEC to improve disclosure.
As one brokerage-related executive noted in a recent Pensions & Investments article, pension funds receiving statements from U.K. firms on how their commissions are used will begin to ask their U.S. money managers for a breakout as well.
Brokerage firms, good at pricing everything in the market, somehow have argued that putting prices on research services and other soft-dollar products is too difficult.
Pension funds, and other clients of money managers, should be asking for soft-dollar brokerage details already; with an SEC rule, managers can no long beg off by providing inconsistent or incomplete information.
Commissions belong to the clients. Pension fund trustees, as fiduciaries, should be held accountable for how those commissions are spent.
"Use of client commissions to pay for research and brokerage services presents money managers with significant conflicts of interest, and may give incentives for managers to disregard their best-execution obligations when directing orders to obtain client commission services as well as to trade client securities inappropriately in order to earn credits for client commission services," the SEC guidelines note.
OK, but disclosure is the best way to make such conflicts untenable, and therefore disappear.
Come on, SEC, grasp the nettle and require disclosure of soft-dollar arrangements and payments.