ICI urging SEC to make soft dollar rules equal for all

By Sara Hansard

WASHINGTON — Everyone should have to abide by the same rules when it comes to using soft dollars, the major mutual fund industry trade group told the Securities and Exchange Commission in a comment letter.

The SEC should prohibit the use of client commissions outside the "safe harbor" for liability protection "by all investment advisers, regardless of the type of client account involved," the Washington-based Investment Company Institute said in comments filed with the commission this month. The letter was signed by ICI General Counsel Elizabeth Krentzman.

The SEC issued interpretive guidance in July on how client commissions can be used without running afoul of securities regulations. With soft dollars, investment advisory firms pay higher fees for trading commissions in exchange for research and other services.

Meanwhile, T. Rowe Price Associates Inc. of Baltimore complained some investment advisers, such as hedge funds, aren't subject to the rules pertaining to the use of client commissions.

"Unfortunately, not all advisers are subject to this (safe-harbor provision)," Henry Hopkins, T. Rowe Price's chief legal counsel, said in a comment letter.

The SEC should adopt a rule "that will prohibit an investment adviser from using client commissions to pay for any products or services that fall outside the safe harbor," according to T. Rowe Price's letter.

Mutual funds and pension plan managers are prohibited from using soft dollars outside of the safe harbor, which generally limits advisory firms from using client commissions to pay for things other than research.

Although firms that use soft dollars outside of the safe harbor may incur greater legal liability, the fund industry argues it gives those firms advantages.

Hedge firms and other advisory firms that are allowed to operate outside the safe harbor "have greater flexibility in what they can pay to execute a trade," said Amy Lancellotta, senior counsel for the ICI.

"They're able to ‘pay up,' and in turn they will often get that first call from the broker when there's a new issue or a sought-after issue," she said.

All firms should have to operate under the same rules, Ms. Lancellotta said.

Independent research firms are happy the SEC made it clear that soft dollars can be used to pay for independent third-party research. Initially, the fund industry had suggested such use of soft dollars be banned. And some mutual fund companies, including industry giant Fidelity Investments and MFS Investment Management Inc., both of Boston, prohibit the use of soft dollars to pay for independent research.

"This is a major step forward by the SEC to clarify the field," said Lee Pickard, a senior partner with Washington law firm Pickard and Djinis LLP, which represents independent third-party researchers.

He objects to fund companies banning the use of soft dollars while at the same time continuing to use soft dollars to pay for proprietary research offered with other brokerage services by wirehouses.

"This should help keep mutual funds from discriminating," Mr. Pickard said.

Another major issue in the soft-dollar guidance is commission-sharing arrangements between mutual funds and brokers. The brokerage industry and mutual funds like the fact that the SEC is allowing more flexibility for such arrangements.

In an earlier proposal, the SEC set forth specific criteria that would have to be met by brokers. That, the Securities Industry Association said in its comment letter signed by General Counsel Ira Hammerman, "would have significantly impaired the ability to continue many of these arrangements" and could have led to "unintended consequences."

But, according to the SIA, which has offices in New York and Washington, it may take some time to evaluate whether the revised guidance "fully resolves the concerns which led to the modifications."

Sara Hansard is Washington bureau chief at InvestmentNews, a sister publication of Pensions & Investments.