SEC Staff Issues Report on Soft-Dollar Practices, September 1998

Washington, DC, September 23, 1998 - The SEC's Office of Compliance Inspections and Examinations (OCIE) has issued a report entitled Inspection Report on the Soft Dollar Practices of Broker-Dealers, Investment Advisers and Mutual Funds. The report summarizes the findings from a series of sweep exams of soft-dollar practices of 75 broker-dealers and 280 investment advisers and mutual funds and contains the following staff recommendations from those findings.

The SEC should publish the report to reiterate guidance with respect to the Section 28(e) safe harbor and to emphasize the obligations of broker-dealers, investment advisers, and investment companies that participate in soft dollar arrangements. In addition, the SEC should reiterate and provide further guidance with respect to the scope of the safe harbor, particularly concerning (a) the use of electronically provided research and the various items used to send, receive, and process research electronically, and (b) the use of items that may facilitate trade execution.
The SEC should adopt recordkeeping requirements that would provide greater accountability for soft dollar transactions and allocations. Specifically, rules should be adopted to require (a) broker-dealers to furnish to each investment adviser a statement of all products, services, and research provided to the adviser in exchange for soft dollars, (b) advisers to keep these statements and, where advisers obtain soft dollar benefits from multiple brokers, to maintain their own detailed list of all products and services received for soft dollars, and (c) advisers to maintain a written record of the basis for allocations of mixed-use products and services between their hard and soft dollar components.
The SEC should modify Form ADV to require more meaningful disclosure by advisers and more detailed disclosure about the products received that are not within the Section 28(e) safe harbor. Such revisions should incorporate the disclosure standard set forth in the staff's 1986 release on soft dollars (i.e., disclosure should be specific enough for clients to understand the types of products being purchased and permit them to evaluate possible conflicts of interest) and should require more detailed disclosure about any products or services that are not used in the carrying out of the adviser's investment decisionmaking responsibilities. In addition, the SEC should require advisers to provide more detailed information to clients upon request. This disclosure could be on a client-specific basis, could include more detailed itemization of the research and products obtained with soft dollars during the previous period, and could include total commission commitments, and total expenses during the period. Finally, Form ADV should be amended to require disclosure of the availability of commission recapture programs to clients if any client of the adviser directly receives cash rebates, products, services, expense payments, or expense reimbursements from one or more broker-dealers based on commissions generated by the client's trades placed by the adviser.
The SEC should publish the report in order to encourage advisers to strengthen their internal control procedures regarding soft dollar activities. The staff suggests that investment advisers review and consider the controls described in the report, many of which were observed as effective during examinations. A summary of such control procedures can be found in Appendix F to the report.