Regulatory Issues > United States
SEC Clarifies Soft Dollar Policy (28e)
In 2005 and 2006 the SEC published guidance regarding client commission practices under section 28(e) of the Securities Exchange Act of 1934.
Euro IRP made two submissions on the subject, the first of which encouraged a consistent approach to global regulation regarding commission arrangements:
- EuroIRP SEC 28(e) response - November 24, 2005
In our more recent submission we were positive about the SEC modifying its interpretation of “provided by” and “effecting” under section 28(e):
- EuroIRP SEC 28(e) response 2 - September 6, 2006
In light of changes in market structure and submissions following the October submission, the SEC looked at the “effecting” and “provided by” terminology, and in its July 2006 release introduced considerably more flexibility. For clarity on this, please see p. 50-54 of “Commission Guidance Regarding Client Commission _Practices Under Section 28(e) of the Securities Exchange Act of 1934” published on July 24, 2006 (http://www.sec.gov/rules/interp/2006/34-54165fr.pdf). With the changes in the “provided by’ interpretation, there is a new option allowing the broker-dealer to create a pool of research dollars, funded by commissions paid by managed accounts, to pay for research services as instructed by the money manager. This type of client commission arrangement (CCA) is similar in many respects to the UK CSA payment structure. Indeed, the SEC introduced this flexibility in part due to submissions from UK organizations, suggesting that unbundling has been influential. The SEC has made it clear that it wants to make it as easy as possible for money managers to pay for independent research.
The SEC’s “no-action letter”
Subsequent to the SEC’s July 2006 guidance on client commissions under section 28(e), the Staff of the Commission’s Division of Market Regulation issued a "no-action letter" on January 17, 2007 to Goldman, Sachs & Co which confirmed that research firms who are not broker-dealers may be compensated for providing research services to their money manager clients through payments from a “commission pool” set apart in a client commission arrangement under section 28(e) without registering as broker-dealers. The payment structure described in the no-action letter is very similar in structure to a UK CSA. The SEC Staff noted that the following factors must be present for a non-broker-dealer research firm to be compensated from a “commission pool” set aside by an executing broker-dealer:
- The money manager must be responsible for independently determining the value of the research services under SEC 28(e), although the money manager’s good faith determination may be based on input from the research firm.
- The broker-dealer may not be involved in determining the value of the research services to the money manager.
- The research firm must receive payment from a pool of commissions that, by agreement between the broker-dealer and the money manager, is set aside for obtaining research services.
- Payment to the research firm may not be conditioned, directly or indirectly, on the execution of any particular transaction or transactions in securities that are described or analyzed in the research services.
- The research firm may provide the research services in return for payment from a pool of commissions, but may not perform other functions that are typically characteristic of broker-dealer activity (e.g., soliciting brokerage transactions by disseminating quotations, accepting or handling customer orders, introducing or carrying customer accounts, receiving or holding customer funds or securities, etc.).
The no-action letter clarifies that research firms who receive payments from commission-generated pools of funds do not have to be registered broker-dealers under certain conditions. The Staff’s position appears to be based on the proposition that the pools lose their character as “commissions” when they are used to compensate a research firm for research and the research firm does not perform broker-dealer functions.