ICI Comments on Proposed Soft Dollar Guidance, November 2005

Background
The Securities Exchange Act of 1934 establishes a safe harbor that allows money managers to use client funds to purchase "brokerage and research services" for their managed accounts under certain circumstances without breaching their fiduciary duties to clients. In October 2005, the SEC issued an interpretive release that proposed to issue guidance with respect to the safe harbor; in particular, by clarifying the scope of "brokerage and research services" in the light of evolving technologies and industry practices.

The SEC sought comment on its proposed interpretive guidance, including whether the proposed guidance has accurately identified the industry practices for which guidance would be most useful, and whether the guidance would significantly affect the level and distribution of costs among industry participants and, if so, whether these effects would be beneficial to investors or otherwise serve the public interest.

ICI Position
In its comment letter, ICI recognizes that the use of soft dollars by investment advisers raises complex policy and practical issues that have been the subject of widespread debate and divergent opinions for many years. The Institute refers to the potential benefits of soft dollar arrangements to investors and also acknowledges the conflict of interest concerns that have led many in the mutual fund industry - including independent fund directors - to recommend that soft dollar practices be curtailed. ICI also mentions its 2003 recommendations for tightening restrictions on soft dollars, including the recommendation to prohibit the use of soft dollars to pay for third-party research.

Overall, ICI expresses support for the proposed guidance, subject to the following comments on specific issues:

The SEC should take steps to level the playing field by prohibiting the use of soft dollars by all investment advisers, regardless of the type of client account involved. This change will ensure that all advisers treat investors equitably in connection with the adviser's use of brokerage, and that broker-dealers will not have financial incentives to favor hedge fund and other advisers who are permitted to use soft dollars outside the safe harbor.
The SEC should modify the proposed guidance to: exclude from the safe harbor publications that are marketed to the general public, and permit money managers to treat order management systems and proxy voting services as mixed use items in appropriate circumstances.
The SEC should clarify that the proposed guidance concerning commission-sharing arrangements does not place any affirmative obligations on money managers with respect to the responsibilities of introducing brokers under the guidance and applicable law, and should ensure that any responsibilities placed on brokers are appropriate and workable.
The SEC should make clear that any final guidance applies on a prospective basis, and should provide a one-year transition period for money managers to unwind or modify, as necessary, existing soft dollar arrangements and to use credits earned under existing arrangements.