Jay Baris serves as chairman of the American Bar Association’s subcommittee on investment companies and investment advisers. Baris spoke with Washington Bureau Chief Stan Wilson about how he advises fund companies on the various aspects of the Securities and Exchange Commission‘s soft dollar guidance.
FD: What did the SEC do, and do you agree with the decisions?
JB: The guidance provides that some proxy services may qualify as research under the safe harbor, to the extent that they provide “research.” In determining whether brokerage services fall within the safe harbor or are available for mixed-use treatment, the SEC adopted a temporal standard as a form of a bright line test. It may be difficult to live with but it is firm guidance that we can understand.
FD: Might some firms simply stop using the safe harbor for mixed-use items expenditures?
JB: The SEC affirmed its 20-year old policy concerning mixed-use items. It allows some flexibility, but at a cost. If you want the safe harbor to cover mixed-use items you must determine in good faith how to allocate the mixed-use item and document the basis of that allocation. It seems like a fair tradeoff. But if the added recordkeeping costs more than the value of the services, asset managers may elect to pay for them in hard cash.
FD: In several cases, whether something can be paid for with soft dollars depends on the intent of the asset manager in using the item. How difficult will it be to demonstrate intent?
JB: It should not be too difficult to demonstrate intent as long as you document how you plan to use the research or brokerage services and how they meet the statutory criteria. This is another recordkeeping issue.
FD: Has the SEC cleared up all questions about the fact that third-party research is meant to be covered by the guidance as permissible under Section 28(e)?
JB: The SEC has settled the question, at least for now. The guidance states that third-party research may qualify for safe harbor protection, provided that the research or service is an analysis, advice or report reflecting an expression of reasoning, or that a broker-dealer providing services complies with the “provided by” criteria, and the broker does not pay an asset manager’s obligations to third parties.
FD: How will the guidance affect parties engaged in soft dollar transactions?
JB: What may have an effect on soft dollar transactions is what may come in the future more disclosure and a move toward unbundling.
FD: What can we expect when the SEC addresses soft dollar disclosure issues?
JB: The SEC will likely require funds to increase prospectus disclosure to provide for more transparency of the actual costs of the research or services provided under the safe harbor. We may see additional lines in the fee tables in fund prospectuses.
FD: What other compliance problems do you foresee?
JB: Recordkeeping and client reporting are high on the list. Advisers should maintain adequate procedures and test them periodically. Keep adequate records of why you conclude particular research or why brokerage services fall within the safe harbor. Keep detailed records on mixed-use allocations. And, of course, make full reports to your fund boards.
FD: Do you think this guidance will cause talk about repealing Section 28(e) to fade?
JB: There was some talk in Congress about repealing Section 28(e). But that initiative seems dead, at least for now. The issue may arise again if a soft dollar scandal explodes or the SEC brings a flurry of enforcement proceedings alleging that advisers abused soft dollars or breached their duty to obtain best execution.