November 13, 1997
The Soft Dollar and Directed Brokerage Working Group
respectfully submits the following report and recommendations to the 1997
ERISA Advisory Council.
I. WORKING GROUP'S PURPOSE AND SCOPE
The 1997 Advisory Council on Employee Welfare and
Pension Benefit Plans created a working group to study the need for
regulatory changes and/or additional disclosure to pension plan sponsors
and fiduciaries on soft dollar and directed brokerage practices. In
choosing this topic, council members expressed concern this area lacked
sufficient guidance for plan fiduciaries to properly administer their
pension plans in compliance with ERISA's fiduciary requirements. In
addition, soft dollar and directed brokerage practices had not been
comprehensively addressed by Department of Labor staff since the
mid-1980s.
The primary objective of this study was to evaluate
current soft dollar regulations and industry practices to determine if
plan sponsors and other fiduciaries were being provided sufficient
disclosure in order to properly protect plan assets. Recommendations
resulting from this study were formulated with the guiding principle that
pension plan assets belong to plan participants and fiduciary decisions
must only be made in the best interest of plan participants. The financial
profitability and viability of financial institutions dealing with soft
dollars and directed brokerage is the primary concern of the Securities
and Exchange Commission and outside the scope of this report. The
Securities and Exchange Commission has a separate study underway
addressing soft dollar and directed brokerage practices with investment
management firms, consultants and brokerage firms.
The first task for the Soft Dollar and Directed
Brokerage Working Group was to define the terms "soft dollars"
and "directed brokerage". Soft dollars can be defined as
"payment for brokerage firm services, other than trade execution,
through commissions generated from investment trades". A more
detailed explanation is:
When investment managers buy or sell stock, the price
of executing the transaction includes price paid or received for the stock
and the brokerage commission. The brokerage commission includes: actual
cost of the trading function; principally executing the trade; clearing;
settling; custody; and the brokerage firms' profit. The brokerage firm may
give up part of their profit to provide credits for investment managers or
consultants who use these credits to pay for research and/or other costs
associated with the investment process. The commission dollars that a
brokerage firm relinquishes in this manner are termed "soft
dollars.<1>
To define "directed brokerage" one must first
define "commission recapture". "Commission recapture"
is a process whereby pension plans receive a rebate resulting from
brokerage transactions incurred through the pension plans' investment
managers. This rebate represents a portion of commissions (equity trades)
or spreads (fixed income trades) charged on these investment
transactions.<2> Knowing this definition, we can now define directed
brokerage as:
When plan sponsors direct investment managers to
execute a portion of their trades through a selected brokerage firm to the
extent the brokerage firm is competitive in price and trade execution. The
brokerage firm then rebates a portion of the commissions to the pension
plan. The pension plan can be rebated in cash or have the brokerage firm
pay certain administrative expenses of ERISA-covered pension
plans.<3>
II. WORKING GROUP PROCEEDINGS
In taking testimony on soft dollar and directed
brokerage practices, the working group received oral testimony from
nineteen (19) witnesses. These witnesses came from four major areas:
Pension and Welfare Benefits Administration of the Department of Labor and
the Securities and Exchange Commission; corporate pension plan
administrators; public pension plan administrators; and financial service
providers. Because of substantial interest in the working group topic,
oral testimony had to be limited. Consequently, approximately forty (40)
individuals were not able to give oral testimony but were encouraged to
submit written statements. Five (5) individuals elected to submit written
testimony that was added to the record. In addition, twenty-eight (28)
written references consisting of periodical articles, newspaper articles,
prepared statements, white papers, prior congressional testimony, industry
group pamphlets, news releases and written testimony of oral witnesses
were added to the record.
The oral testimony, written testimony, and public
comments on soft dollars and directed brokerage were received by the
working group in a series of five public hearings. During the first public
hearing held on April 8, 1997, the working group received testimony from
representatives of the two federal agencies primarily responsible for
regulating and monitoring soft dollar and directed brokerage practices.
Mr. Morton Klevan, Pension and Welfare Benefits Administration, provided
the working group an overview of fiduciary standards as they relate to
soft dollars and directed brokerage. Mr. Klevan first defined "soft
dollars" and how they differ from "hard dollars". He then
discussed how soft dollars are used by investment managers to purchase
goods and services for their own use while paying for them with funds
generated from clients' brokerage commissions.
Mr. Klevan then distinguished "directed
brokerage" from soft dollars. He then discussed application of DOL
Technical Release 86-1 and its fiduciary obligations for plan sponsors
electing to utilize directed brokerage programs. Mr. Klevan closed his
testimony discussing the Department of Labor's previous enforcement
efforts concerning soft dollars.
The Security and Exchange Commission's (SEC's) recent
sweep of 355 investment managers, consultants and brokers was the subject
of testimony from Mr. Gene Gohlke, SEC Inspections Office. The SEC is
looking for pervasive, not isolated, practices by firms involved with soft
dollars and directed brokerage. The sweep concentrated on third party
research providers, which is an area the SEC noted prior abuses. The SEC
was also concerned about weak internal controls in many firms for
monitoring purchases and sales of research.
Due to input plan fiduciaries have in initiating direct
brokerage programs, the SEC was not going to examine directed brokerage as
closely as other soft dollar practices. However, the SEC will check to see
if directed brokerage guidelines established by plan sponsors are being
followed by investment managers and consultants. Mr. Gohlke concluded his
testimony stating he would send the working group a copy of the final SEC
report as soon as it was available.
Mr. William Quinn, AMR Investment Services, began May
13, 1997 testimony with his recommendation to repeal Section 28(e) of the
Securities and Exchange Act of 1934<4> to reduce conflicts of
interest between plan participants and investment managers. He stated soft
dollars are not used in most parts of the U.S. economy and should not be
an allowed practice in money management where trust and integrity of
service providers is critical. ERISA<5> provides investment managers
sufficient latitude to act responsibly without the safe harbor provided by
Section 28(e). Mr. Quinn was followed by Mr. Harold S. Bradley and Robert
T. Jackson, American Century Investors, who gave their perspective on soft
dollars from the viewpoint of an investment management company. They
recommended investment managers be required to disclose to plan sponsors
how managers pay for all research purchases. In addition, all research
provided to investment advisors should be disclosed on Form ADV filed with
the Securities and Exchange Commission.
Mr. William McIntosh, Independent Financial Consultant,
recommended elimination of Section 28(e) as part of his June 13, 1997
testimony. He stated it amounts to a $1.2 billion deceptive practice on
plan sponsors due to inadequate disclosure. Eliminating Section 28(e)
would help improve accounting practices for investment transactions and
introduce true competition into the market place for commission rates.
Gary Findley, Executive Director and Richard Dahl, Chief Investment
Officer, Missouri State Employees' Retirement System, shared examples of
soft dollar abuses with the working group. Disclosure is the key to
discouraging soft dollar abuses and requires plan sponsors have investment
managers and consultants disclose all soft-dollar sources of income at
time of hire. Mr. Findley also stated the greatest of portion of soft
dollar monies go unreported and are not disclosed to plan sponsors.
Mr. R. Charles Tschampion, GM Investment Management
Corporation, wanted to retain Section 28(e), but stated the Securities and
Exchange Commission should further clarify the definition of
"research" to better determine what can justifiably be
purchased. Investment managers and brokers should disclose uses of soft
dollars for all clients, so plan sponsors can monitor activity across all
client accounts.
The July 16, 1997 testimony began with Mr. Roland
Machold, New Jersey Division of Investment, who discussed soft-dollars
being used in the internal administration of his public plan investment
program. Mr. Machold testified that he does not receive sufficient funding
from the New Jersey State Legislature and utilizes soft-dollars to pay for
needed administrative expenses. For pension plans utilizing soft-dollars
in this manner, he advocated an exacting accounting process with full
disclosure, even to the point of third-party auditors reviewing all
commission transaction records.
Responding to questions regarding his interpretation of
Section 28(e) of the Securities and Exchange Act of 1934, Mr. Machold
stated he felt the current interpretation of "research" should
be expanded to include travel expenses. He did not want to see the
definition of research limited to only those goods that can be purchased
with hard-dollars. He preferred the expanded "research"
definition to make available for purchase any research service providing
assistance in the investment process.
Kenneth L. Kahn, Alpha Management, Inc., shared results
of his firm's recent industry survey on directed brokerage. The survey
outlined arguments both pro and con in use of directed brokerage by plan
sponsors. The survey covered 212 pension plans ranging from sizes from
$200 million to $38.5 billion in size. Participants listed reasons for
using directed brokerage as (1) lower commission costs; (2) payment of
consultant fees; and (3) payment for research. Reasons for not using
directed brokerage were (1) utilize passive or indexed assets; (2) leave
this function up to money managers; (3) money managers advised against
directed brokerage; and (4) concern about not getting "best
execution".
Managers are taking advantage of excess commissions and
soft-dollars and this amounts to a second, hidden management fee. He also
stated small plan sponsors receive an inordinate reward because the
majority of research costs are paid by larger pension plans. In response
to questions, Mr. Kahn said the current definition of "research"
under Section 28(e) should be tightened to better define what goods and
services could legitimately be purchased.
Mr. Jan Twardowski, Frank Russell Securities, also
directed his testimony to directed brokerage. His firm runs directed
brokerage programs he claims save clients an estimated $40 million
annually. His clients save from 40% to 70% of commission costs by
utilizing directed brokerage. Frank Russell Securities recommends clients
limit directed brokerage to approximately 25% of total securities
transactions. Mr. Twardowski testified he had no direct evidence of soft
dollar or directed brokerage abuses. Without such evidence, the SEC and
DOL should not change current regulations. Proof of widespread abuse must
be a precondition to any new regulations.
Ms. Tina Byles Poitevien, Fiduciary Investment
Solutions, Inc., provided a history of soft-dollars in the investment
industry and specific data from surveys on soft-dollars expenditures.
According to Ms. Pointevien's testimony, only 25.9% of investment managers
were almost always or always satisfied with the quality of execution they
received through directed brokerage programs.
Directed brokerage programs worked best on easy trades
involving large capitalization stocks, that are exchange listed and traded
in quiet markets. Ms. Poitevien quoted a 1995 Plexus position paper that
found directed brokerage clients receive less than best execution, because
investment managers put directed brokerage trades last when making
difficult trades. In response to questions from working group members, Ms.
Poitevien recommended the Securities and Exchange Commission adopt a
specific list of acceptable research purchases. Everything on that list
must be directly related to the investment function.
The working group had heard from two (2) prior
witnesses recommending eliminating Section 28(e) for pension plans and
that same recommendation from Mr. Bryce Barnes, Quantel Associates,
covered no new ground. However, Mr. Barnes made a unique recommendation in
advocating adding questions to Form 5500 to insure plan sponsors are
complying with ERISA Technical Release 86-1, which he felt was now largely
ignored. His second recommended change to Form 5500 was to revise
instructions for Schedule C requiring plan sponsors list all fees greater
than $5,000 paid to investment managers with soft dollars.
Mr. Herbert C. Skinner, Jr., Investment Performance
Services, stated that much of the confusion over commission recapture
programs was because plan sponsors did not understand the trading process.
Commission costs are just one component of overall trading costs and could
be the smallest. The best way to minimize execution and opportunity costs
were to allow investment managers the flexibility to (a) minimize market
timing and impact costs; (b) get best execution; and (c) utilize brokerage
firms who can provide liquidity. Mr. Skinner stated plan sponsors could
best fulfill their responsibilities by placing their recapture brokerage
firms in competition with the rest of industry to provide best execution
on each trade. Plan sponsors who utilize directed brokerage are relieving
their investment managers from some or all their fiduciary responsibility
for best execution and assuming that responsibility themselves.
Representing the Securities Industry Association (SIA),
Mr. Howard J. Schwartz updated the working group on progress by the SIA
panel looking into best practices in use of soft-dollars. Best practices
are needed because individuals have alleged soft-dollar arrangements are
deceptive, present conflicts of interest, constitute hidden profits and
result in something less than best execution. Mr. Schwartz stated the best
practices would cover disclosure, procedures for brokerage dealers and
fiduciaries to monitor, effects of market forces, and would probably not
recommend elimination of Section 28(e) which would potentially cause both
practical and theoretical problems.
Jack M. Marco, Marco Consulting Group, began the
September 17, 1997 meeting by stating there were three (3) parts to
directed brokerage -- the "good", the "bad" and the
"ugly". The "good" was directed brokerage could result
in significant savings to the pension plan. The savings could be used to
offset plan administrative expenses and, if done correctly, would not
interfere with investment managers' execution of trades. The
"bad" was when plan sponsors over-directed trades by utilizing a
single brokerage firm for more than 25% to 30% of overall trades. Another
bad feature of directed brokerage programs is, if not structured properly,
they could interfere with managers' execution of trades. Mr. Marco also
testified he knew of directed brokerage programs where clients never
received promised rebates or paid five to six times higher than the actual
cost of services provided.
The "ugly" of directed brokerage programs is
many arrangements are done orally with very little written evidence.
Therefore, it becomes very difficult for plan sponsors to properly monitor
the entirety of soft-dollars arrangements affecting their plan assets.
Mr. Marco recommended plan sponsors insist on "no
other compensation" clauses in their contracts with consultants.
These clauses would prohibit consultants from accepting any compensation
unless specifically covered by the contractual agreement. Another Marco
recommendation was third-party audits be utilized to review all trades
made by investment managers for the plan sponsor's account. Without
independent third-party confirmation of trading practices, plan sponsors
could not determine if consultants are complying with contractual
agreements.
Mr. Samuel W. "Skip" Halpern, Independent
Fiduciary Services, organized his testimony around specific questions plan
sponsors can ask in selecting investment managers, monitoring investment
managers' performance, and monitoring brokerage. Questions plan sponsors
should ask when utilizing consultants to select investment managers are:
(a) Is any manager candidate favored or disfavored because of their level
of trading with an affiliated broker-dealer of the consultant? (b) How
much in commissions has each candidate paid their consultants'
broker-dealer in the recent past? (c) How much in spread securities has
each candidate traded with the consultant's broker dealer?
The questions for plan sponsors to ask when monitoring
investment managers' performance are: (a) What portion of total equity
trades is each investment manager conducting through consultant's broker
dealer on this account and others? (b) What percentage of total fixed
income trading is conducted through consultant's broker dealer on this
account and others? (c) In both cases, how much of this trading involves
soft dollars and specifically what does each manager receive in return?;
(d) How much in total compensation (both hard and soft dollars) does the
consultant and its broker dealer receive from this account?
Lastly, questions plan sponsors should ask when
monitoring brokerage practices are: (a) What subjects have plan sponsors
specifically hired the consultant to address? (b) Do plan sponsors pay the
consultant through directed brokerage or participate in a commission
recapture program? (c) Does anyone with sufficient expertise and
independence monitor brokerage activities on behalf of the pension plan?
Some final recommendations Mr. Halpern left with the
working group are plan sponsors should require written soft-dollar
disclosures from consultants. In addition, plan sponsors should request
brokers and consultants supply them with written copies of their projected
soft dollar and directed brokerage budgets annually.
Oral testimony for the working group concluded with
remarks from Mr. Barry P. Barbash and Mr. Steven M. Wallman, Securities
and Exchange Commission, who provided a report on progress to date on
SEC's recent "sweep" of 355 investment managers, brokers and
consultants. The report was being compiled and had not yet been approved
by the Commissioners for release to the public. Mr. Barbash stated he
would make a copy available to the working group upon release by the
Commissioners.
III.FINDINGS AND RECOMMENDATIONS
Soft dollar and directed brokerage practices involve
responsibilities for plan sponsors, administrators, and other fiduciaries
created by ERISA's fiduciary duties under Section 404<6> and
prohibited transaction provisions under Section 406.<7> ERISA
Section 404 states a fiduciary's overriding responsibility is to
"discharge his duties with respect to a plan solely in the interest
of the plan participants and beneficiaries and for the exclusive purpose
of ... defraying reasonable expenses of administering the plan.<8>
This duty to act for the exclusive purpose of providing benefits and
defraying expenses is known as the "exclusive purpose rule". The
exclusive purpose rule also charges fiduciaries with responsibility for
keeping administrative expenses at reasonable levels maintaining accurate
record keeping, and monitoring service providers. Fiduciaries must
administer affairs of the plan in the best interests of plan participants
and beneficiaries alone and exclude from consideration interests of third
parties. Fiduciaries must also avoid transactions involving self-dealing
conflicts of interest or use of plan assets to benefit
parties-in-interest.<9>
These legal responsibilities are the basis which
require plan fiduciaries to closely monitor plan expenses. Soft dollar and
directed brokerage programs are funded through use of commission dollars.
Soft dollars and commission rebates generated by investment managers
through trading activities are plan assets, and both plan sponsors and
investment managers have fiduciary responsibilities regarding their
prudent management and oversight as they do with other plan assets.
After reviewing the testimony, the working group
developed specific recommendations which fall into two main categories.
The first category are recommendations involving a change to current
regulations or statutes. The second group are recommendations for plan
sponsors and other fiduciaries to follow in their relationships with
investment managers, consultants, and brokerage firms. The recommendations
involving regulatory or statutory changes can be further divided into two
(2) subgroups. The first subgroup contains recommendations within the
purview of the Department of Labor. The second subgroup involves
recommendations the Department of Labor can make to the Securities and
Exchange Commission. Each of the following recommendations stand
independently and are not cumulative.
Recommendations Involving Regulatory or Statutory
Change
DEPARTMENT OF LABOR RECOMMENDATIONS:
A. Modify Form 5500 requiring plan sponsors to list all
fees greater than $5,000 paid with directed brokerage.
B. Add a question to Form 5500 requiring plan sponsors
to certify they are complying with requirements of ERISA Technical Release
86-1 in using directed brokerage programs.
DEPARTMENT OF LABOR RECOMMENDATIONS TO SECURITIES AND
EXCHANGE COMMISSION:
A. Securities and Exchange Commission should tighten
Section 28(e) definition of "research" to better determine what
can justifiably be purchased with soft dollars.
B. Securities and Exchange Commission should prepare a
specific list of which brokerage and research services are acceptable
purchases with soft dollars.
C. Investment Managers should be required to provide to
each client full disclosure of all trades for that client involving soft
dollars and the benefits investment managers receive from those soft
dollars. In addition, investment managers should be required to provide a
description of their policies involving soft dollars.
D. External research provided to investment managers
must be disclosed in summary form on Form ADV filed with the Securities
and Exchange Commission.
The recommendations listed above are those in which
there was agreement by a majority of working group members. There were two
additional recommendations, not supported by a majority, in which the
minority working group members requested their opinion be included along
with the majority opinion.
E. The working group minority recommended repealing
Section 28(e) for employee benefit plans only, thereby eliminating the
safe harbor for research purchases.
Majority Opinion
Soft dollars, used prudently, can provide investment
managers with much needed information allowing them to perform better for
clients. Plan sponsors should make decisions on how best to use pension
plan assets, including commissions, by balancing factors such as best
execution, need for research, and all costs, including brokerage
commissions.<10> Under this argument, the ability of brokerage firms
to provide research services in return for commissions encourages more and
better research. Both the SEC and Congress have acknowledged the positive
effects of research on investment decision making. In a 1972 study
addressing brokerage and other practices published prior to the enactment
of Section 28(e), the SEC noted "it is essential that the viability
of the process by which research is produced and disseminated not be
impaired.<11> Approximately 90% of investment managers in the United
States obtain research through soft dollars.<12> Consequently,
removal of the Section 28(e) safe harbor could have widespread negative
effects throughout the investment management industry.
Trade groups representing the soft dollar industry had
claimed competition for order flow from the soft dollar industry has
exerted downward pressure on commission rates and has reduced the costs of
execution and research. According to a March, 1997 report by the Alliance
in Support of Independent Research, "the competition for
institutional order flow by research brokers and other broker dealers have
brought down the cost of trading from a high of 82 cents per share in 1975
to an average of 6 ½ cents today.<13>
Minority Opinion
Eliminating Section 28(e) for employee benefit plans
would not preclude use of soft dollars, but only require all soft dollar
purchases be solely in the best interest of plan participants and
structured to avoid prohibited transactions. Investment managers would
need to get plan sponsors prior approval and then fully disclose all
research related purchases. This could be done by investment managers
submitting a soft dollar budget to plan sponsors for approval each year
and then later submitting a report of actual expenditures. Who can argue
against giving plan sponsors this information which is key to fulfilling
their fiduciary responsibilities under ERISA. In addition, elimination of
Section 28(e) would not prohibit use of directed brokerage or commission
recapture programs.
Use of soft dollars for research purchases essentially
results in a management fee above and beyond the "handsome" fee
already negotiated by managers.<14> Soft dollars allows investment
managers to use clients' trading activity to pay for their research.
Research services should be purchased by investment managers for cash if
they are deemed necessary.<15> Soft dollar commission fees are
really hidden fees, which are not permitted in any other
business.<16>
Section 28(e) should be repealed for employee benefit
plans to reduce conflicts of interests between beneficiaries and fiduciary
managers and allow investment managers to focus on best execution and
lower overall commission costs. The safe harbor provisions of Section
28(e) are too broad to protect ERISA plans and they remove accountability
for soft dollar relationships. ERISA already provides investment managers
with sufficient latitude to act in the best interest of plan participants
and beneficiaries in trading without the safe harbors provided by Section
28(e).<17> The need for Section 28(e) has passed. It may have been
created for good reasons and in a sea of good intentions. But, its day is
over.<18>
F. The working group minority recommended eliminating
use of soft dollars for employee benefit plans. Brokerage firms would be
required to unbundle their services and investment managers must pay
separately for execution and research with hard dollars.
Majority Opinion
Commission recapture programs and soft dollar
arrangements have complimented each other and fostered competition in
brokerage industry. Competition provided by these innovative programs has
ultimately benefitted the pension plan participants by increasing the
amounts of commission dollars credited back to pension plans. Commission
recapture programs have provided pension plans the choice plan sponsors
want by unbundling services and allowing plan sponsors to determine if
commissions are being used optimally for their particular plan. When done
correctly, directed brokerage does not interfere with managers' trade flow
and can generate significant income back to the pension plan.<19>
The U.S. Department of Labor has already established
guidelines for plan sponsors electing to use directed brokerage
arrangements. As long as directed brokerage programs stay within the
guidelines established by DOL Technical Release 86-1<20>
, they should be allowed to continue. DOL Technical
Release 86-1 permits the purchase of goods and services, other than
research, as long as: purchases are made on behalf of the pension plan;
total compensation paid to the broker is reasonable; best execution of
trades is obtained; and plan sponsors monitor brokers for best
execution.<21>
Directed brokerage does not undermine best execution
because today directed brokerage trades are handled exactly like
non-directed trades. In the past, when a manager was faced with a mixture
of directed and non-directed trades, the manager would often send the
non-directed trades, together as a block, and then send the directed ones
individually. The first block of non-directed trades would normally get a
better price than later individual directed trades, causing less than best
execution for the directed trades.<22> Managers have now developed
"step-out" trades, where managers ask non-directed brokers to
transfer (step-out) a certain percentage of transactions to directed
brokers. Thus, directed transactions get the same execution as
non-directed transactions, in addition, to plan sponsors getting their
directed rebate.<23>
If a plan sponsor does not direct, then their plan may
be subsidizing every other pension plan's research.<24> Although
directed brokerage signifies work for plan sponsors, the money saved on
commissions is well worth it. As fiduciaries, plan sponsors should be
monitoring their investment managers and brokers anyway. Besides, managing
directed brokerage programs is no longer difficult in light of the
evolution of investment technology.<25>
Likewise, a properly structured commission recapture
program can assist investment managers, reduce plan costs, and help plan
sponsors fulfill their fiduciary responsibilities. The key is to give
investment managers a number of highly-respected firms with which to
trade, no specific directions in trading, and give them the ability to do
executions and transactions as they see fit, and still save money for the
pension plan.<26>
Minority Opinion
Use of soft dollars effectively results in an
additional fee above and beyond the agreed to fee by both parties. Use of
soft dollars allows investment managers to use a client's trading activity
to pay for their research. Research services should only be purchased by
the investment manager for cash, if they are deemed necessary.<27>
Use of soft dollars is analogous to an airline asking
passengers to use their own credit cards to buy fuel for the flight from
one destination to another after they have already paid for their ticket.
Obviously, passengers would not approve of this arrangement, and neither
should investment managers be allowed to benefit from undisclosed soft
dollar arrangements.<28> Many investment managers receive excessive
amounts of research, which they readily admit much of which is not needed.
Purchasing unneeded research keeps the overall commission cost structure
higher than it would otherwise be.<29> According to a 1991 Greenwich
Associates Report, portfolio managers only read approximately 30% of
research reports they receive. Investment managers at the largest funds,
read only about half that amount.<30> Evidence again of plan assets
being wasted.
Eliminating soft dollars should not appreciably impact
market liquidity. Larger brokerage firms generally are willing to act as
principals in making markets at higher commission costs to provide
liquidity for investors, and the small percentage of trades requiring it.
Trades requiring liquidity assistance comprise probably less than 20% of
all trades; however, widespread use of soft dollars tends to drive up
costs on the other 80% of trades where liquidity is not a
factor.<31>
Directed brokerage undermines a managers' ability to
get best execution. By directing to a particular broker, plan sponsors
influence investment managers' ability to obtain best execution; thus, any
savings plan sponsors may experience in commission dollars are really a
greater loss on the execution side.<32> According to a 1991 survey
conducted by Rodney L. White, Center for Financial Research, only 25.9% of
investment managers were almost always or always satisfied with the
quality of execution for directed brokerage.<33>
DOL Technical Release 86-1 places a substantial burden
on plan sponsors for monitoring reasonable brokerage compensation and best
execution of trades for directed brokerage programs. Technical Release
86-1 clearly says if a plan sponsor steps in to pick up responsibility for
a portion of the trading function (by entering a directed brokerage
program) the plan sponsor has an obligation to monitor for reasonable
brokerage fees and achievement of best execution.<34> Plan sponsors
do not know the right questions to ask investment managers and brokerage
firms to get information they need to meet fiduciary obligations of
Technical Release 86-1.
In many cases, plan sponsors are individuals who do
carpentry work, do plumbing work and make and sell widgets.<35>
Clearly, these individuals are not capable of making informed investment
decisions and monitoring sophisticated investment mangers and brokerage
firms having much greater financial expertise than they do. In one-sided
situations such as this, the entire advantage is in the corner of
investment managers and brokerage firms. These one-sided conflicts can
best be avoided by simply eliminating the source of conflict which is soft
dollar use in employee benefit plans.
Recommendations Involving Plan Sponsor Guidance
ERISA places substantial responsibilities on plan
sponsors and other fiduciaries charged with overseeing administration and
investments of pension plans. Responsible plan fiduciaries either do not
understand their role and responsibilities or do not have sufficient
experience or an appropriate source of information concerning legal
requirements and industry practices to deal with soft dollar and directed
brokerage programs. Therefore, the working group concluded that
educational information would be very useful for all plan sponsors and
other fiduciaries and would particularly benefit fiduciaries of small and
medium-size pension plans. While additional educational materials will not
change behavior of those acting in their own best interest or choosing to
disregard their fiduciary obligations, it could still discourage
activities by educating responsible fiduciaries to recognize improper
conduct.
The working group makes the following recommendations
in an effort to further educate plan sponsors and fiduciaries. These are
individual recommendations and are not collective.
A.Plan sponsors should avoid soft dollar conflicts of
interests by hiring only consultants with no financial arrangements with
brokerage firms.
B.Soft dollar income disclosure to plan sponsors by
investment managers and consultants should be audited by independent
accountants as long as cost beneficial.
C.Plan sponsors should obtain copies of brokers' and
investment managers' projected directed brokerage budgets and, if
applicable, soft dollar budgets.
D.Soft dollar brokerage monitoring should be done only
by parties with sufficient expertise and independence, with no vested
interests to protect.
E.All contracts with investment managers and
consultants should require written disclosure of potential conflicts of
interest.
F.Contracts with consultants should require disclosure
of all compensation they receive from investment managers either through
the sale of services or through directed brokerage arrangements.
G.Investment managers' contracts should require
disclosure to plan sponsors of how managers pay for research and how the
pension plan benefitted from that research.
H.Plan sponsors should have consultants and investment
managers acknowledge their fiduciary status in writing.
I. Plan Sponsors should obtain written confirmation of
oral representations made by consultants and investment managers regarding
brokerage arrangements.
J. Plan Sponsors should create specific guidelines for
responsible soft dollar and directed brokerage programs.
Endnote References for Sections I, II and III (May be
found at end of Working Group Report)
IV.SUMMARY OF ORAL TESTIMONY
The following constitutes a brief summary of oral
testimony given by witnesses who testified before the Working Group on
Soft Dollars and Director Brokerage.
April 8, 1997 Meeting
MORTON KLEVAN
Senior Policy Advisor
Pension & Welfare Benefits Administration-DOL
Mr. Klevan defined "soft dollars" as
"when you use other people's money to buy something for yourself.
Hard dollars is when you take it out of your own pocket. This situation
arises when investment managers purchase goods and services for their use,
but pay for them with client's brokerage commissions. These purchases
would normally be prohibited transactions for ERISA plans if not for
Section 28(e) of the Securities and Exchange Act of 1934. This safe harbor
allows investment managers to pay higher commission rates if they receive
research services in addition to trade execution. Safe harbor protection
is available for investment managers only and does not apply to plan
sponsors.
Mr. Klevan then distinguished "directed
brokerage" from soft dollars. Directed brokerage is when plan
sponsors recapture on behalf of the plan a portion of brokerage commission
dollars to pay for custodian fees, accounting fees, performance
measurement and other administrative costs. Plan fiduciaries must assure
investment managers obtain best execution on directed brokerage trades and
commission rates are reasonable considering difficulty of the trades.
However, Section 28(e) does not require research services be used solely
for the benefit of the client whose brokerage commissions are paying for
those services.
Mr. Klevan made two suggestions for fiduciaries to
avoid conflict of interest difficulties with their consultants. His first
suggestion was that fiduciaries only hire consultants who have no soft
dollar arrangements with brokerage firms. His second suggestion was for
plan sponsors to then have consultants acknowledge their fiduciary status
in writing. Lastly, Mr. Klevan discussed Department of Labor's enforcement
efforts in the area of soft dollars. There has been only one 1989
enforcement case filed on record. Currently, no other cases are being
prosecuted and soft dollars is not a current area of emphasis for
enforcement.
GENE GOHLKE
Associate Director-Inspections Office
Security and Exchange Commission-Inspections Office
Mr. Gene Gohlke provided a progress report on the
Securities and Exchange Commission's (SEC's) most recent "sweep"
of approximately 350 investment management firms, consultants, and
brokers. The inspection sweep included both ERISA and non-ERISA plans and
is looking for pervasive, not isolated, practices in soft-dollar usage.
The SEC initiated this study for several reasons. The first reason was the
increasing number of soft-dollar enforcement cases being filed by the SEC.
Second, was the significant publicity this subject received in recent
press articles and, lastly, because the last SEC comprehensive evaluation
was over ten (10) years ago and the SEC wants to investigate compliance
with its current rules.
To date, SEC staff has completed all field work and
interviews with the 350 plus participants. Field work notes are now being
compiled into a first draft report. The sweep concentrated on third-party
research providers rather than firms providing proprietary research. Mr.
Gohlke noted most prior abuses were arrangements involving third-party
research. He also believed the current sweep would result in enforcement
cases being filed. Preliminary results indicate a need for additional
disclosure to plan sponsors. SEC staff found substantial discrepancies
between amounts of research purchased and disclosure of information
regarding those purchases to plan sponsors.
Section 28(e) of the Securities and Exchange Act of
1934 provides a safe-harbor for investment managers and consultants to
purchase research services with soft-dollars. This safe-harbor keeps the
purchase of research-related items from being prohibited by the SEC. In
his testimony, Mr. Gohlke defined "research" to include such
things as Bloomberg terminals, periodical subscriptions, performance
measurement evaluations, computer software, PC's, conference fees, but not
all travel expenses. He stated some travel by research analysts may fit
under the Section 28(e) exception. Mr. Gohlke felt it would be a problem
for ERISA plan trustees to attend conferences and seminars where their
expenses were paid by soft-dollars from that plan. This practice could be
a prohibited self- dealing transaction for ERISA plan trustees.
Another area of SEC concern were the weak internal
controls in place in many investment advisory firms and broker dealers.
Research purchases and sales were not being tracked and accounted for
properly. Staff in charge of research purchases and sales were operating
with minimal oversight. SEC staff was also concerned by possible bogus
research shops being set up to split research fees.
The SEC sweep was not going to look as closely at
directed brokerage practices. The reduced scrutiny is because plan
fiduciaries have directed transactions to particular brokerage firms who
will share some portion of commission dollars with the plan. However, the
SEC will check to see if directed brokerage guidelines established by plan
sponsors are being carried out by investment managers. SEC staff was going
to closely examine the amount of disclosure provided to plan sponsors,
because some practices were felt to require informed consent prior to
being carried out. Hedge funds were especially bad about soft dollar
expenditures not related to research.
May 13, 1997 Meeting
WILLIAM F. QUINN
President
AMR Investment Services
Mr. Quinn began his testimony with a description of AMR
Investment Services ("AMR") and its corporate policy with
respect to soft dollar trading. In connection with its pension plans, AMR
oversees both external and internal managers. AMR instructs its equity
managers that soft dollar trading should not be used in its portfolios
either to obtain research or pay for any plan or mutual fund expenses. AMR
believes the best way to achieve best execution on all trades is to
eliminate any potential conflicts of interest that would be introduced by
soft dollar practices.
Mr. Quinn explains what he perceives as the problems
with soft dollar trading and AMR's method of compensating for the
inefficiencies created by these practices. Soft dollar trading allows
external managers to use trading activities to pay for their research --
research that should be paid by the manager with hard dollars if necessary
-- which is not fair to AMR. These practices cause cost inefficiencies
either because AMR may receive less favorable execution or because AMR
pays for bundled trading and research that may not benefit it or other
clients. AMR thus encourages its managers to utilize automated trading
systems or discount brokers. (About 20% of the dollar volume of trades are
executed on a discounted basis.) In addition, AMR monitors its managers'
trading practices to determine whether they have received any research
services. From this process, AMR determined that for over 70% of the
fully-priced trades, managers received research services, but at the best
price and at the lowest cost, i.e., "essentially for free." Mr.
Quinn believes, however, that because managers tend to receive excessive
research, the overall commission cost structure is higher than it would
otherwise be. AMR has also witnessed some questionable practices by
managers, but Mr. Quinn has never seen a manager abuse his or her
fiduciary status in connection with soft dollar trading.
In conclusion, Mr. Quinn recommends that Section 28(e)
be repealed to reduce conflicts of interest between fiduciaries and
managers, to focus managers on best execution and lower overall commission
costs incurred by investors. Mr. Quinn believes the safe harbor provision
of 28(e) is too broad to protect ERISA plans, removes accountability for
soft dollar relationships and is not necessary in light of ERISA's ability
to provide investment managers with sufficient latitude to act in the best
interest of beneficiaries. In the event that Section 28(e) is not
repealed, Mr. Quinn recommends that (a) brokerage firms unbundle their
services and have managers pay execution and research separately with hard
dollars or (b) managers fully disclose soft dollar trades and the benefits
received therefrom.
In response to questions from the panel, Mr. Quinn had
these comments:
-First, that there is a division among industry pension
groups as to benefits associated with soft dollar trading depending on
whether the plan primarily uses outside investment advisors or internal
management.
-Second, he sees no advantage to paying for research
through commissions because it only serves to obfuscate the costs to
pension plans. Mr. Quinn goes on to describe a method by which soft dollar
trades could be reported in the event that Section 28(e) was not repealed.
-Third, Mr. Quinn suggests investment advisors could
provide greater disclosure in their form ADV about their brokerage
allocation practices, and in particular, describe commissions amounts
generated by brokers and the amount research received from brokerage
firms.
-Fourth, the definition of "research" is
subjective and rather than establish guidelines as to what should be
disclosed, require managers disclose the cost of trading and question the
costs that appear to be associated with research.
-Fifth, 401(k) plans are probably more subject to
abusive soft dollar practices because they invest in mutual funds which
have not, until recently, been scrutinized by the SEC.
-Sixth, Mr. Quinn states assessing the value of
research is very difficult and the practical answer to soft dollar trading
is full disclosure.
HAROLD S. BRADLEY AND ROBERT T. JACKSON
Director of Equity Trading and Chief Financial Officer
American Century Investment Management
Messrs. Bradley and Jackson presented an asset
management company view that soft dollars are not currently being
accounted for. They provided background on the evolution of soft dollar
practices, which according to a Greenwich Associates report approaches
$1.3 billion in value.
They stated that buy side traders are in a conflict
whether to serve the interests of investor- shareholders or the management
company shareholders, an example would be when traders could forego best
price to pay bills without the sponsors' knowledge. Using a conversion
ratio of 1.6, at least $375 million of profits have accrued to investment
management companies that are not adequately disclosing soft dollar usage.
They suggested full disclosure of third-party services
paid with soft dollars in equivalent hard dollar amounts can be
accomplished by asking traders how they pay their bills and requiring
investment advisors to disclose all research purchases on form ADV filed
with the Securities and Exchange Commission.
June 13, 1997 Meeting
WILLIAM A. MCINTOSH
Independent Financial Consultant
Mr. McIntosh testified that using soft dollars was a
deceptive practice and results in a second and undisclosed management fee
for investment managers. Commission rates of 6 cents per share, originally
intended to provide competition, has now become a charade. Any commission
expense over one and a half to two cents per share is pure profit for
brokerage firms. This excessive profit leads to conflicts of interest that
in Mr. McIntosh's opinion are no different than "money
laundering". Rather than working diligently for best execution, many
investment managers are under extreme pressure to avoid best execution and
actually inflate commission rates to make more soft-dollars available.
Four parties should benefit from each soft dollar transaction. However,
Mr. McIntosh believes only three parties are currently benefitting.
Brokers get commissions, money management firms get free research and
research services sell more product. The fourth party are plan sponsors
who receive nothing, but pay the entire transaction cost.
Mr. McIntosh said the only answer is to eliminate
Section 28(e) of the Securities and Exchange Act of 1934. Current
operations under 28(e) amount to a $1.2 billion deceptive practice because
of inadequate disclosure. The original reasons for establishing Section
28(e) are no longer applicable. Section 28(e) was first established to
protect small research firms and give them the same quality execution as
larger firms. Technological improvements in market transactions now give
small firms the ability to get quality execution like large firms. In
addition, Mr. McIntosh felt there would be no reduction in quality of
research available and managers would quickly pay for research with hard
dollars if they needed it.
Eliminating Section 28(e) would help improve accounting
practices for brokerage firms and investment managers tracking and
accounting for investment transactions. Another benefit would be
eliminating supplementary budgets for pension plan administrators who use
soft-dollars to pay for operating expenses. Using soft dollars to pay for
plan expenses amounts to a secondary off- budget source of financing which
is not always properly accounted for. The last benefit of eliminating
Section 28(e) was that true competition for commission rates would be
introduced to the marketplace and rates would drop accordingly. Mr.
McIntosh believed SEC Commissioners were receptive to eliminating Section
28(e), but would act only if pushed by public attention to this issue.
GARY FINDLAY AND RICHARD DAHL
Executive Director and Chief Investment Officer
Missouri State Employees Retirement System
Messrs. Findlay and Dahl provided the perspective of
public plan administrators and fiduciaries of a large public pension
system. They spoke about their experience with soft dollars and directed
brokerage, citing examples where investment consultants were to be paid
only modest hard-dollar retainer fees and eventually received ten to
twenty times that amount in soft dollar fees. The soft dollar fees were
received either from investment managers the consultant hires in exchange
for a share of investment management fees or from an affiliated broker to
whom the investment manager directs an inordinate amount of trades
credited to the consultant's account. They also confirmed that most monies
involved in soft dollar and directed brokerage transactions go unreported.
They then described Missouri PERS mechanisms for
discouraging abuse in soft dollar practices. The system is funded solely
through trust fund assets and has an experienced in-house investment staff
that meets with prospective investment managers and advises the Board on
investment issues. The system also places caps on average brokerage
commissions.
They cited as their principal concern the plan
sponsor's responsibility, when hiring a consultant, to request information
in writing on the consultant's relationships with outside service
providers. They emphasized that disclosure is key, which can be
accomplished by plan sponsors asking lots of questions and requiring
written answers from consultants and investment advisors.
(A sample questionnaire may be found in the article,
"In Pursuit of Objectivity in Investment Counseling," Plan
Sponsor Magazine, November 1996, pp 66-77.)
R. CHARLES TSCHAMPION,
Managing Director of Investment Strategy and Asset
Allocation
General Motors Investment Management Corporation
Mr. Tschampion began his testimony with a description
of General Motors Investment Management Corporation ("GM") and
its policy with respect to soft dollar trading. GM manages $65 billion of
defined benefit pension funds using both external and internal managers.
GM expects its managers to generate reasonable commission costs and
monitor their commission practices. GM engages in commission recaptures
with primarily one firm, the Frank Russell Company and informs its
managers that although they are not required to direct their commission
business through Russell Securities, they are encouraged to do so.
Mr. Tschampion spent the bulk of his testimony
addressing difficulties in defining what constitutes "research"
with respect to soft dollar practices and his recommendations to the
working group. There is, for example, "market trading research"
in which the broker helps a customer determine what to sell and when. The
next level of research consists of useful information generated by a
brokerage firm pertaining to the market which can assist a manager in
making industry or stock selections. There is also "access
research" (an even "softer" form of research) in which the
firms pays a third party expert to give his or her views on the market
which may only be pertinent to the asset allocation practices of the fund.
At each level it becomes increasingly difficult to assess whether the
customer should pay for the research provided. Ultimately, Mr. Tschampion
believes the test is whether the research aids in the investment decision
process for the investment manager's or the client's account.
Because of inherent difficulties in determining which
research a customer should pay for, Mr. Tschampion recommends managers
simply disclose the services they are acquiring for their commission
dollars. In addition, managers should maintain records that disclose both
on an individual client basis and on a firm basis services obtained for
the commission dollars received. In this way, plan sponsors could
determine whether there has been an inappropriate use of commission
dollars by investment managers.
The bulk of the questions raised by the panel focuses
on GM's commission recapture program. Mr. Tschampion describes the program
as recapturing 50 to 70 percent of the commission generated to pay
primarily for consulting fees or, in the case of an overage, to pay for
other plan expenses noting that any expenses paid for under such a program
must be legitimate.
Mr. Tschampion recommended the working group consider
further defining "research" under Section 28(e), but concludes
that it may ultimately prove very difficult and the working group may be
better off simply defining the safe harbor parameters of Section 28(e).
Mr. Tschampion believes that it would be very difficult to provide
guidelines as to what constitutes "reasonable research" and
defers to the guidance provided in the AIMR and CIEBA letters. Finally,
Mr. Tschampion recommends that Section 28(e) not be repealed stating that
so long as the research is legitimate and enhances the investment
decision-making process, systems should not be created to restrict and
impair research services.
July 16, 1997 Meeting
ROLAND M. MACHOLD,
Director
New Jersey Division of Investment
Mr. Machold begins his statement with a discussion of
the seven pension funds managed by his Division and the Division's
position with respect to soft dollar trading. Mr. Machold notes that all
pension funds are managed internally together with numerous State funds
and that the costs associated with managing such funds are
"minuscule" -- slightly less than one basis point. The Division
strongly supports use of commission dollars to purchase research and other
services for the benefit of pension fund members. The Division also
supports full disclosure of all commissions, a clear definition of
eligible services and close monitoring and accounting for all commissions.
Mr. Machold notes that as all funds are managed internally, there is no
conflict of interest between plan sponsors and any managers (internal or
third party managers), there is no need to engage in commission recapture
programs and there is no need to worry about misappropriation by fund
managers.
Mr. Machold spent the bulk of his testimony discussing
use of commission proceeds in his funds. Nearly 40% is used to pay for
"research services" which include general publications, economic
services, performance measurement, corporate research, consultants,
subscription services, various information data banks, and certain
research packages which may include expenses for travel and room and
board. None of the services provide personal advantages to the personnel
of the Division or support the general overhead of the Division.
In conclusion, Mr. Machold made the following
recommendations: First, the current scope of Section 28(e) as it applies
to investment managers and not to plan sponsors remain the same in any
amended versions of Section 28(e). Second, a broad definition of research
that can be purchased with commission dollars be adopted. As Mr. Machold
points out, since research expenses are not paid for by the New Jersey
legislature, a broad definition is critical in light of the Division's
limited resources, including travel and hotel expenses. The Division would
not like to limit the definition either (a) to services which are not
customarily available and offered to the public on a commercial basis or
(b) to expenses delineated as research versus non-research (as this line
is too imprecise). Third, he recommended that the broadest disclosure
requirements and any independent reviews are implemented noting the
Division reviews and evaluates research and execution capabilities of
every broker semi-annually and discloses every transaction and every
commission monthly. In sum, Mr. Machold states commission dollars are
essential to managing the funds the Division supervises and the Division
would oppose any radical changes in the standards and interpretations that
are currently expressed in Section 28(e).
KENNETH KAHN
President and Chief Operating Officer
Alpha Management, Inc.
Mr. Kahn testified eighty percent of plan sponsors are
either satisfied or very satisfied with their directed brokerage programs.
His survey results listed arguments against directed brokerage. First,
directed brokerage undermines managers performance by preventing
"best execution". Secondly, sequencing of directed trades is a
problem. Some directed brokerage firms have poor execution. Third,
managers need commission dollars to purchase research. Proprietary and
soft dollar research is necessary to enhance management performance.
Fourth, commissions pay for the broker's willingness to commit capital.
Lastly, the management of directed trading is an unnecessary burden for
the plan sponsor. The savings realized is not worth the time or the
commitment required to manage a directed brokerage program.
The arguments for directed brokerage from the survey
are as follows. First, "best execution" is no longer the
problem. Directed trades are handled exactly the same as non-directed
trades. Directed brokers have become major trading firms. There have been
created vast global correspondent networks and step-outs. The issue for
plan fiduciaries whether the plan derives additional benefits in
investment services from their commission dollars.
Second, the issue has become that plans have legitimate
needs. Commissions impact the bottom line. Growth of assets and turnover
of portfolios have created excess commissions. Eighty percent of a plan's
returns are attributable to strategic decisions of the plan. Specific
stock selection accounts for only 20 percent of returns. Many plans do not
have adequate funding to support internal research requirements.
Third, managers are taking advantage of excess
commissions. Purchases of soft dollar services by managers amounts to a
second, hidden management fee. Plans who don't direct brokerage may
subsidize the plans that do direct. The commission savings are well worth
the small effort. Plan fiduciaries are required to have a process for
managing investment expenses.
Mr. Kahn supports modification of Section 28(e) to
better define "research." Mr. Kahn supports the use of soft
dollars because he believes plan sponsors want an unbundling of research
and execution because unbundling lowers plan sponsor cost.
JAN TWARDOWSKI
President
Frank Russell Securities
Frank Russell Securities has been in the directed
brokerage business since 1969. By combining the buying power of its
clients' $700 billion dollars in assets, Frank Russell Securities is able
to negotiate favorable directed brokerage pricing with major brokerage
firms around the world. Frank Russell clients are able to achieve
discounts of 40 to 70 percent from the fully-negotiated commissions
clients normally pay. The savings total about $40 million dollars a year.
These savings come in the form of rebates from Frank Russell Securities to
the client.
In total dollars, directed brokerage dollars are mostly
used to pay various Russell fees. Cash refunds to the client is the second
most frequent use. Frank Russell Securities also pays third-party invoices
for clients primarily in investment analysis, data services, custody fees
and consulting services. Payments are made only after a fund fiduciary
gives express instructions and states that the expenses are bonafide fund
expenses.
Mr. Twardowski reads ERISA as requiring securities
firms to provide quarterly statements to clients showing for each
transaction a complete breakout of who gets what portion of commissions,
how much executing brokers keep, how much clients get back and how much
Frank Russell retains. In other words, full disclosure of gross margins.
Frank Russell Securities believes "best
execution" remains of paramount importance. Mr. Twardowski believes
it is far more important than saving a few cents per share on commissions.
Investment managers always retain the best execution responsibility. Frank
Russell Securities recommends a maximum of 25% direction by its clients.
Frank Russell finds larger percentages can sometimes constrain the
broker's ability to achieve best execution.
Mr. Twardowski does not believe there has been abuse of
soft dollars in directed brokerage. He could not remember receiving a
request that would skirt the edge of the regulations by the DOL or SEC,
much less violate them. No investment manager has asked them to pay a
service fee that is not clearly within the 28(e) safe harbor. No fund has
requested Frank Russell Securities pay for something that is not clearly a
legitimate expense of a pension fund.
Based upon Frank Russell's experience, they are of the
opinion that commission abuses by managers or funds are not at all wide
spread in the pension investment industry. If abuses exist, there appear
to be ample and specific remedies under the securities laws and in ERISA
for both the SEC and the Department of Labor to correct any abuses as they
occur.
Mr. Twardowski doesn't believe pension plans are hurt
by Section 28(e). Mr. Twardowski recommends that Section 28(e) be
"developed" further through industry rather than regulatory
solutions. He believes AIMR will come up with industry input standards
that are more specific than Section 28(e) while providing for more
disclosure.
TINA BYLES POITEVIEN
President
Fiduciary Investment Solutions, Inc.
Ms. Poitevien testified there are two separate
unrelated practices under the soft dollar umbrella. The first is soft
dollar transactions that are, when properly structured, covered under
Section 28(e) for research purposes. The second is soft dollar
transactions not covered under Section 28(e) that involve commissions on
orders that plan sponsors direct to a particular brokerage house, i.e.
directed brokerage. These dollars are used to obtain research and other
products for client's use.
Ninety percent of all money managers in the United
States obtain research through the use of soft dollars. Approximately $600
million of brokerage commissions spent annually by money managers are
converted into soft dollars. Most studies show a preponderance of soft
dollars being expended on market and stock research, security quotations
systems and databases.
Statistics state 52% of institutional investors have
soft dollar arrangements with brokerage firms or money managers. Within
this group, 41.2% of commissions generated through such directed brokerage
arrangements were rebated to pension plans. In addition, the most
prevalent use of soft dollars by plan sponsors and trustees was defraying
costs of consulting, actuarial and custodian costs. Notably consistent
with the institutional investment study, 44.4% of respondents said their
plan sponsor clients use directed brokerage for commission recapture.
The controversy surrounding soft dollars basically
involves the following:
(1) what constitutes appropriate research service;
(2) what level of disclosure should be provided to
consumers of investment management services and products purchased through
soft dollars; and
(3) impact of soft dollar transactions particularly in
combination with directed brokerage on the ability of investment managers
to obtain best price execution.
Any clarification of the definition of legitimate soft
dollar expenses should consider the following: (1) what research services
are directly related to the investment process; (2) what products or
services should be treated as a firm wide overhead expense; and (3) is
there a threshold above which the diminishing returns negate legitimate
research expenditures. For example, according to a 1991 Greenwich
Associates Report, many portfolio managers read only 30 percent of
research reports they receive. Managers of the largest funds read only
about half of that amount.
Trade groups representing the soft dollar industry
claim competition for soft dollars has exerted downward pressure on
commission rates and has reduced the cost of execution. Directed brokerage
arrangements have particularly been criticized for compromising execution
quality. Most studies have found directed brokerage or soft dollar
arrangements work best when management strategies consist of "easy
trades" such as large capitalization stocks that are exchanged listed
and traded in quiet markets.
Tina Poitevien recommends keeping Section 28(e), but
requiring increased disclosure and definition of what constitutes
research. She suggests use of a definitive list of the types of
expenditures representing qualifying research.
HERBERT C. SKINNER, Jr.
President
Investment Performance Services
Mr. Skinner's testimony was limited only to the subject
of Commission Recapture Programs (CRP) for pension plans, and not
"soft dollars" used by investment managers. He recited under
ERISA, trustees are charged with prudent fiduciary responsibility to
control plan costs. He noted Commission Recapture Programs allow pension
plans to recapture a significant percentage of commissions when executing
trades by the plan's investment managers.
If properly structured, with no direction and no
minimum dollar amount or specific percentage of business designated,
investment managers are not inhibited from achieving "best
execution" in the trading process. In fact, execution costs (getting
the best price) is much more important than commission charges and can
have three times the impact. He emphasized it is critically important that
plan sponsors be offered the largest and best Wall Street brokerage firms
included in a Commission Recapture Program.
Mr. Skinner testified the largest brokerage firms
offering best institutional execution will not unbundle costs directly to
plan sponsors. If they reduce their commission charges below 5-6¢ per
share for one manager they would have to reduce for all. Brokerage firms
will sell to a firm like his and others, who are NASD members, execution
services only at a substantially reduced cost allowing them the ability to
rebate to their clients. The main reason they have these relationships is
to increase order flow through their trading desks and generate additional
commission revenue they otherwise would not receive.
Mr. Skinner pointed out that the worst thing that can
happen in a Commission Recapture Program is the plan sponsors receive no
"recaptured" rebate. On the other hand, if investment managers
can use brokers offered, then plan sponsors can receive a substantial
check and reduce expenses up to 50%. This, he emphasized, can be achieved
without altering the way investment managers handle their orders and does
not inhibit them in any way from receiving "best execution".
BRYCES BARNES
President
Quantel Associates, Inc.
Mr. Barnes stated rather emphatically that SEC Rule
28(e) should be eliminated for pension plans. His argument was the current
tangle of exemptions has spawned fixed rate commissions (at close to
$.06/share) and an industry of rebaters who function solely to get around
these fixed rates. He stated pension funds should be allowed to achieve
economies of scale directly by negotiating commissions.
Mr. Barnes articulated that the Pension Welfare Benefit
Administration Technical Release 86-1 clearly defines obligations for plan
sponsor that become involved in the trading function. He offered the
opinion that these obligations are largely ignored by plan sponsors.
Therefore, he recommended the Department of Labor add questions to Form
5500 for the plan sponsor to disclose compliance with Technical Release
86-1.
In his final observation, he noted that Schedule C of
Form 5500 - Instructions states - "Item 2 of Part I must be completed
to report all persons receiving, directly or indirectly, $5,000 or more in
compensation for all services rendered to the plan during the plan
year". To deal with this he recommended a clarification to the
instructions that would require disclosure of service provider fees paid
through soft dollars and/or directed brokerage.
HOWARD J. SCHWARTZ
Chairman and Chief Investment Officer
Lynch, Jones and Ryan, Inc.
Mr. Schwartz began his testimony by stating his firm,
Lynch, Jones and Ryan, Inc. is probably most responsible for the
development of the commission recapture concept. He explained commission
recapture results from plan sponsors directing their investment managers
to execute a percentage of equity and fixed income trades through
designated brokerage firms. Brokers will then rebate a percentage of
income resulting from trades directly back to plan sponsors. Plan sponsors
may receive rebates in cash or brokerage firms may pay for plan
administrative expenses.
As more brokerage firms entered the commission
recapture market increased competition resulted. This competition has
resulted in two (2) benefits for plan sponsors. The first benefit is
increasing amounts of total commissions are being credited back to plan
sponsors. Secondly, competition has resulted in increased plan sponsor
education of the potential benefits offered by commission recapture.
Approximately 15% of pension plans nationwide are now utilizing commission
recapture programs.
Mr. Schwartz then discussed the history of Section
28(e) of the Securities and Exchange Act of 1934 and reasons why it was
implemented. Mr. Schwartz believes Congress passed Section 28(e) to allow
for payment of research which is a valuable service offered to investment
managers and the benefits are passed on to pension clients.
Mr. Schwartz concluded his testimony by outlining plan
sponsors' fiduciary responsibility in determining if plan commissions are
used to benefit plan participants. Plan sponsors should periodically
review how commissions are being used; what portions are allocated for
recapture, if any; what portions are used for research; and what portions
are needed in trade execution. Plan sponsors should keep in mind that the
goal of the fiduciary is to obtain the best return on investments for plan
participants while maintaining appropriate risk levels. Trading practices
should first seek to obtain best execution and brokerage services are only
a small part of the overall investment process.
September 17, 1997
JACK M. MARCO
President
Marco Consulting Group
Mr. Marco testified the good side of directed brokerage
is that it provides significant savings to plans and can be used to offset
other plan expenses. Done correctly directed brokerage does not interfere
with investment managers' execution. The only question is whether
investment managers receive the full benefit, in the form of services, of
the brokerage directed or if the plan receives any benefit. Plan's should
get the benefit of directed brokerage because it represents plan assets.
If directed brokerage is done correctly with full disclosure, it can be
very beneficial for pension plans.
The bad aspects of directed brokerage include
"over directing", where a plan instructs its investment managers
to place a very high percentage of trades with a certain broker, and
direction programs utilizing discount brokers. Both these practices
adversely affect investment managers normal trading patterns. Investment
managers have told Mr. Marco a directed brokerage arrangement should
mainly use large institutional brokers for trading. This type of direction
does not affect the managers' trading patterns and execution.
From the standpoint of the plan, commission dollars are
plan assets but the investment manager may view commissions as perks that
they can distribute. There are a lot of brokerage firms from which
managers may choose and who they choose to deal with is a perk they can
distribute. If used properly, these perks provide managers with research
that benefit plans. If used improperly, perks provide investment managers
with personal benefit and access to new business.
Another problem is inadequate reporting of what
commissions are purchasing. For example, a consultant may offer a service
for "free" or a brokerage firm may offer custodial services if
the plan uses the brokerage firm for trades. These arrangements often do
not spell out how much must be traded through the brokerage firm or how
much the commissions are worth. In his experience, such arrangements with
no set fee result in total commissions significantly greater than the
consultant would get if he established a fixed fee.
Finder's fees are also an ugly problem. In this
scenario, a broker/consultant conducts an investment manager search for a
plan. However, the consultant only recommends investment managers who if
selected will direct a certain percentage of the plan's brokerage to this
broker/consultant afterwards.
The easiest, simplest, and currently untraceable way of
paying a consultant is through commissions. Many consultants have a
brokerage arm or a brokerage clearing arrangement. The investment managers
simply trade through the consultant's brokerage arm for the credit of the
consultant. Mr. Marco stated he could make more money by accepting such
trades than he is making for services he provides to clients. He
recommends consultants not accept trades by investment managers unless
directed on behalf of one of the consultant's clients and pursuant to a
written commission recapture arrangement.
Mr. Marco recommended plan sponsors require consultants
to disclosure annually all income they receive directly or indirectly from
investment managers. Consultant contracts should state they receives no
compensation from any one dealing with the plan and they will report any
future compensation from any one dealing with the plan. He acknowledged
such disclosure could be a problem for large broker consultants in which
the brokerage arm does business with many investment managers but that
disclosure could be provided with respect to the consulting division. He
feels disclosure is the only way to stop the conflicts of interest.
Mr. Marco also recommended plan sponsors require the
pension plan auditor or consultant's independent auditor verify all
commissions to the consultant have been properly paid in accordance with
client directed brokerage arrangements and that no income has been
received from other sources.
Mr. Marco recommended any communication concerning the
level of investment managers direction should come from plan sponsors and
not from consultants. Also, evidence of a high level of direction through
only particular brokerage firms when the investment manager has full
discretion should be the basis for questions by plan sponsors on how they
make decisions concerning brokerage firms.
SAMUEL W. "SKIP" HALPERN
President
Independent Fiduciary Services, Inc.
Mr. Halpern discussed problem areas, from his personal
experience when consultants are compensated with directed brokerage.
First, do investment managers provide the pension plan with quality
securities execution if they engage in trading practices to influence
investment consultants? Second, what is the value and objectivity of
consultants advice concerning both investment managers and their
evaluation? Third, are fees (direct and indirect) to both investment
managers and the investment consultant reasonable? Finally, are procedures
of the plan sponsor adequate to monitor and protect the fund from
potential conflicts?
Mr. Halpern noted when a consultant also provides
brokerage service--either because the consultant is a subsidiary of a
broker-dealer or the consultant affiliates with broker-dealers to offer
commission recapture arrangements--it can create problems. If the
consultant is an ERISA fiduciary with respect to investment advice, the
prohibited transaction rules of ERISA apply. Many abuses that arise are
forms of self-dealing and are violations of ERISA's prohibited transaction
rules. Even if the consultant is not a fiduciary, problems can still
result in liability for plan sponsors and for investment managers. The
issue is whether investment managers are using plan assets--commission
dollars--in the plan's best interest or their own.
Mr. Halpern stated plan sponsors must focus on what
specific functions the consultant is to perform and be alert to possible
conflicts with respect to those specific functions. When a consultant
advises plan sponsors in selection of investment managers, plan sponsors
should require disclosure by both investment managers and consultants. The
critical information plan sponsors should seek is whether any investment
manager candidates are favored or disfavored by consultants based on their
level of trading with broker-dealer affiliates of consultants. Plan
sponsors should attempt to determine how much in commissions investment
managers have paid to consultant's broker-dealer affiliate in recent years
and for what. This question should also be asked with regard to
commissions as well as principal trades and bond trades. Plan sponsors
should also ask how much trading investment manager candidates will do in
the future with consultant's broker-dealer affiliate on this account and
all other accounts. Mr. Halpern noted his written testimony materials
provided a list of specific disclosure items that plan sponsors should
include in request for proposals (RFPs) for consulting services.
When consultants are retained to monitor investment
managers' performance, plan sponsors should ask consultants to disclose
how much in commission business, fixed income trading or principal trading
each of the plan's investment managers is doing through consultant's
broker-dealer affiliate not only on the fund's account but on other
accounts. Plan sponsors should also ask how much trading involves soft
dollars and what does each manager receive in return.
Plan sponsors should ask each investment manager for
their current directed brokerage or soft dollar budget. This lists parties
to whom investment managers expect to direct commissions during the year
and services they anticipate in return. In one case, an investment
manager's budget included many entries for well-known investment
consulting firms who have broker-dealer affiliates. In each case, the
service listed in return for commissions was "performance measurement
analysis". The obvious questions for plan sponsors is how much
performance measurement analysis does one investment manager need and what
is the real motivation for paying these commissions to different
consulting firms in the same year and for the same service?
Finally, if consultants are retained to monitor
brokerage, plan sponsors should insure consultants have sufficient
expertise and independence to perform this function. Either someone
independent of consultants, or consultants themselves if they do not have
a broker-dealer affiliation, should monitor the conversion ratio in
commission recapture or directed brokerage programs, total level of
brokerage consultants get, and whether trades through consultants stop
after a hard dollar equivalent fee has been reached.
Mr. Halpern made two (2) specific recommendations:
First, he stated plan sponsors should separate the consulting function
from the brokerage function. Someone without a financial stake in the
outcome should monitor different functions. Second, he believes written
disclosure both in response to an RFP and on an ongoing basis should be
required from both consultants and investment managers listing total
amounts of brokerage applicable investment managers do with consultant's
broker-dealer affiliate for all accounts.
BARRY BARBASH
Director-Division of Investment Management
Securities and Exchange Commission
Mr. Barbash indicated the Securities and Exchange
Commission (SEC) has been very concerned about soft dollar practices since
the addition of Section 28(e) to the Securities Exchange Act of 1934. The
Commission's concerns stem from the opportunity soft dollar practices
provide for a conflict of interest between investment managers and their
clients; their potential for causing managers to breach their fiduciary
duty to seek best price and execution; and from incentives they provide
for a manager to "churn" or over-trade an account in order to
generate soft dollar credits. From a broader perspective, the Commission
is also concerned soft dollars could lead to market inefficiencies in
pricing of both brokerage and advisory services.
Mr. Barbash testified the Commission historically has
dealt with the issue of soft dollars by three ways: (1) issuing
interpretive guidance as to the meaning and operation of Section 28(e),
i.e., what services constitute "research" within the safe
harbor; (2) proposing disclosure initiatives; and (3) bringing enforcement
actions. He described the enforcement actions as involving either
investment managers engaging in illegal activities depriving clients of
soft dollar benefits or as nondisclosure cases where investment managers
used soft dollars for services other than research.
Mr. Barbash then described some of the Commission's
more recent initiatives which tended to focus on disclosure. He described
the Commission's 1995 adoption of amendments sought to reflect services
received by funds under directed brokerage arrangements. In 1995, the
Commission also proposed a rule requiring investment advisers to disclose
products and services received from primary brokers and aggregate
commission information for each broker. The Commission received many
negative comments on the proposal from many sources, including plan
sponsors, who thought they could get better information by simply asking
their investment managers for information.
Response to the proposed rule contributed to the
Commission's decision to conduct a sweep examination because the
Commission wanted a full picture of soft dollar practices. Mr. Barbash
also clarified at this point that he was speaking for himself, and not on
behalf of the Commission.
Mr. Barbash next described the Commission's 1997 sweep
examination of soft dollar practices, which involved 75 brokers and 280
advisers. He indicated the Commission's report was not yet complete and he
could only make preliminary observations on their findings. The Commission
found many institutional investors, including registered investment
managers, registered investment companies, pension funds, and trust
companies, are engaged in soft dollar practices. The Commission also found
most soft dollar arrangements are oral, not written, and that a third of
the brokers examined provided "non-research, non-execution
services". Such services included rent for the manager travel,
salaries of personnel, postage, parking, furniture, and, in one case,
college tuition. He indicated that such soft dollar payments are not
prohibited so long as there is full disclosure and consent by plan
sponsors.
The Commission further found brokers viewed soft dollar
compliance as investment manager's responsibility, not their own. He
indicated Commission staff were surprised at this because they believed
that prior statements of the Commission placed some, albeit different,
responsibilities on brokers. Mr. Barbash also stated the Commission found
a great deal of variability in the quality of disclosure by managers,
ranging from ?simple boilerplate" to "well-stated
policies". Finally, the Commission found there was considerable
confusion about what constituted "research" in terms of
applicability of Section 28(e) safe harbor.
Mr. Barbash then offered his views on where the
Commission would be focusing in the future. He expected a disclosure
initiative aimed at investment managers to be forthcoming as part of
revamping Form ADV. He also expected more enforcement actions to be
brought as a result of the sweep. Finally, Mr. Barbash noted many trade
associations are also focusing on the soft dollar area.
In response to a question about proposed changes to
Form ADV, Mr. Barbash indicated they would try to reformulate the
questions to receive more specific and clear information. Mr. Barbash
indicated the Commission's report on soft dollars would probably be
finished sometime in the Fall and may become public. In response to
another question, Mr. Barbash indicated in theory, directed brokerage is
arranged by plan sponsors so plan sponsors can get benefits resulting from
execution. This differs from situations where the benefit goes to the
investment managers which involves a conflict of interest and thus
disclosure and consent.
STEVEN H. WALLMAN
Commissioner
Securities and Exchange Commission
Mr. Wallman began his testimony by stating he was
offering his own personal views on soft dollar practices and not
expressing views of the Commission. He explained his approach to the issue
focuses less on current legal distinctions and more on where the law
should go, why soft dollar practices exist, whether they are inherently
"bad", and whether they can be eliminated by changing the
underlying economic reasons for their existence. He began this discussion
by stating some soft dollar usages, such as funding vacations or college
tuition without client consent, are simply inappropriate and constitute
"fraud". He indicated such breaches of fiduciary duty, including
the duty of best execution are problems regardless whether soft or hard
dollars are used to pay for them. He doesn't see the problem as being
caused by soft dollars themselves, they are just the currency that is
often used.
This led Mr. Wallman to whether there was any reason to
distinguish between hard and soft dollars when used to make appropriate
expenditures and why soft dollars were being used. He indicated different
people use soft dollars for different reasons. He stated the fee table
disclosure required of mutual funds led to use of soft dollars to gain
competitive advantages because transaction costs are not included in the
table. Reducing the amount of reported fees could be accomplished by
actually reducing expenses or by directing brokerage to brokers giving
soft dollar credits. Since those who do not use soft dollars look like
they are charging higher advisory fees to retail investors, usage of soft
dollars become pervasive.
Mr. Wallman then testified he believes some public
pension funds can face budget problems. When extra expenses arise, public
pension funds must either seek additional appropriations, a difficult
task, or use soft dollars as an alternative source of revenue. He
indicated soft dollars provide an off-balance sheet method of augmenting
operating budgets. Turning to investment advisors, he indicated soft
dollars allow managers to bid for contracts stating lower expenses and
fees than they could demonstrate if paying for everything in hard dollars.
While a sophisticated plan sponsor or consultant would understand the
effect of soft dollars, Mr. Wallman indicated it could be difficult to
explain the differential in rates to oversight committees.
Having explored why different parties used soft
dollars, Wallman then discussed possible solutions. He thought eliminating
or severely restricting soft dollar usage would not work because current
users could simply look to integrated full service providers which utilize
"internalized" soft dollars. He also stated eliminating or
severely restricting soft dollars could lead to joint ventures and
affiliations providing similar bundled services for a flat commission
rate. Thus, he did not believe a "regulatory, command and control
type of solution" would work. He also thought requiring disclosure of
an implied "fair value" of services whether provided by
integrated full service brokers or soft dollar arrangements was difficult
because of valuation problems. Finally, he did not believe narrowing or
clarifying Section 28(e) would get to the root of the problem.
Also, in the question and answer session, Mr. Wallman
did answer one question. The summary was, "In response to a question
as to whether the commission would consider disclosure in the financial
statements by the reporting of embedded transaction fees, Mr. Wallman
indicated that reporting of transaction fees is a very complex issue
because of the different commission rates and services available, because
strategies involving the market impact of large transactions can lead to
higher transaction costs, yet lower overall cots since over the counter
mark-ups are not considered transaction fees. He indicated that regulating
in one area, transaction fees, would just route the behavior elsewhere.
V. WRITTEN MATERIALS PLACED OF RECORD
(Disclaimer: *Official transcripts/executive summaries
of the W.G. are available for a fee from the DOL-contracted official court
reporter, Bayley Court Reporting, for the April through October, 1997
meetings. Bayley's telephone number is 202-234-7787 and the exact dates of
the meetings must be requested. Contact is Mike Shuman. As of the November
meeting, the DOL's official court reporting contract changed and that
contractor is Executive Court Reporting at 301-565-0064.
Any item ** (double starred) in the index is available
for the private source, e.g. association, company, etc., as it is
proprietorial in nature. It is not in the purview of the DOL to distribute
private organizations' sales and marketing materials.
The final report of the Working Group will be available
via hard copy from the Public Disclosure Office of the Pension and Welfare
Benefits Administration at 202-219-8771, or via the Department of Labor's
Internet Address: http://dol.gov/dol/pwba around the first week of
December, 1997. Questions regarding the Council charter, membership,
nominations process, study issues and other related matters may be
addressed to
Sharon Morrissey, Executive Secretary, at 202-219-8921
or 202-219-8753 or via fax at 202-219-5362.)
Index for Soft Dollar and Directed Brokerage Working
Group
April 8, 1997 Meeting
a) Agenda
b) *Official Transcript
c) *Executive Summary of Transcript
d) Pre-package from Chairman Wood on Soft Dollar
definitions
e) Technical Release 86-1, issued by the PWBA on May
22, 1986
f) Written Remarks of Presentation Made to Working
Group by Howard J. Schwartz, President and Chief Executive Officer of
Lynch, Jones & Ryan, Inc., who also later provided the **company's
Independent Research Sourcebook, Global Edition 1996-1997 and a proposal
from the company's Plan Sponsor Services to save money for XYZ
Corporation, 1997.
May 13, 1997 Meeting
a) Agenda
b) *Official Transcript
c) *Executive Summary of Transcript
d) "The Provisions of Investment Services by
Broker-Dealers: A Guide to Soft Dollar Practices", a white paper
provided by Pickard and Dijinis, written by Lee A. Pickard, Senior Partner
of this Washington D.C. law firm. (This paper was developed by the
Alliance in Support of Independent Research, a group of broker-dealers and
other financial institutions with a common interest in fostering a
favorable regulatory environment in which research services and products
may be furnished to the money management community and in preserving the
umbrella of protection that Section 28(e) of the Securities Exchange Act
of 1934 provides to fiduciaries receiving research services.)
e) Several news stories including:
1) "Some Regulatory Rain on the Managers'
Parade?" New York Times, dated May 11, 1997.
2)"Soft dollar probe: An SEC offensive targets
broker-dealers, investment advisors and mutual funds" , Plan Sponsor
Magazine, dated April 1997.
3)"Take a Hard Look at Soft Dollar Deals; SEC
Scrutinizing Rebates Stock Account Managers Get for Steering Business to
Brokers" by Brett D. Fromson, The Washington Post, December 10, 1996.
4)"Soft-dollars Exam Given by SEC: Mutual Fund
Advisers are Targeted" by Vineeta Anand, Pensions & Investments,
December 9, 1996.
5)"Soft dollars, Hard Sell", Institutional
Investor, December 1996.
6)"SEC to Review Brokerages' Payments to
Investment Advisers" by Brett D. Fromson, The Washington Post,
November 5, 1996.
7)"Changes in Trading Give Investors Edge" by
Barry B. Burr, Pensions & Investments, September 30, 1996.
f) Testimony of William F. Quinn, President of AMR
Investment Services.
g) Copy of the outline of testimony from witnesses
Harold S. Bradley and Robert T. Jackson of American Century Investment
Management, Kansas City, Mo., plus:
1)Paper from the 1994 Mutual Funds and Investment
Management Conference on Soft Dollars and Other Portfolio Issues, pages
3-11.
2)List of vendors whose services or products can be
purchased with soft dollars.
3)Congressional testimony before Subcommittee on
Telecommunications and Finance Committee on Energy and Commerce, U.S.
House of Representatives, Paul G. Haaga, Jr., Senior Vice President of
Capital Research and Management Company, Los Angeles, California, July 13,
1993.
4)Transcript of oral testimony in July before the same
Committee by Anson Beard, Managing Director of Morgan Stanley Group, Inc.,
concerning soft dollar commission practices in securities markets.
June 13, 1997 Meeting:
a) Agenda
b) *Official Transcript
c) *Executive Summary of Transcript
d) Outline of Planned Testimony by R. Charles
Tschampion, CFA, managing Director of General Motors Investment Management
Corp. (GMIMCo) plus Soft Dollar Schematic and:
1)Association for Investment Management and Research (AIMR)
Letter of May 19, 1995 to Jonathan G. Katz of the SEC on the disclosure by
investment advisers regarding soft dollar practices.
2)Financial Executives Institute's Committee on
Investment of Employee Benefit Assets letter, also to Mr. Katz, dated May
15, 1995 on soft dollar practices disclosure.
e) Outline of Teleconference Testimony of Gary Findlay,
Executive Director of the Missouri State Employees Retirement System (MOSERS)
on Pursuing Objectivity in Investment Consulting, accompanied by a Plan
Sponsor Magazine article, November 1996, by Findlay and Steven Yoakum,
Executive Director of the Public School Retirement System of Missouri.
f) Outline of Planned Testimony of William A. McIntosh,
Financial Consultant, June 13, 1997.
g) Wall Street Journal article, "SEC Brings Action
Targeting Abuses of Soft Dollars", May 30, 1997.
h) Written testimony of Roger D. Blanc, Wilkie Farr
& Gallagher on Soft Dollar Practices of Brokers, Investment Managers
and Hedge Funds.
July 16, 1997 Meeting:
a) Agenda
b) *Official Transcript
c) *Executive Summary of Transcript
d) Prepared Remarks of Roland Machold, Director of the
Division of Investments, New Jersey Division of Investments, Newark, NJ.
e) "Directed Brokerage - The Arguments for and
Against" and "Two perspectives on Plan- Sponsored Directed
Brokerage" presented by Kenneth Kahn, President and Chief Operating
Engineer, Alpha Management, Inc.
f) Testimony Outline from Jan Twardowski, President of
Frank Russell Securities, Tacoma, WA.
g) Testimony of Tina Poitevien, President and Chief
Executive Officer, FIS Funds Management, Inc.
h) Outline from Bryce Barnes, President, Quantel
Associates, Inc.
i) A Presentation by Herbert C. Skinner, Jr., President
and Principal, Investment Performance Services.
j) Outline of presentation of Howard J. Schwartz,
President, Lynch, Jones & Ryan and a **copy of the Securities Industry
Association's pamphlet on "Best Practices:A Guide for the Securities
Industry." Also included is a news release issued by SIA on
Schwartz's appointment to the panel chairmanship.
k)Pensions & Investments article: "Ennis,
Knupp Cuts Soft Dollars", June 23, 1997.
l)Letter from William A. McIntosh, Independent
Consultant and June witness, as a follow-up to his appearance.
September 17, 1997 Meeting:
a) Agenda
b) *Official Transcript
c) *Executive Summary of Transcript
d) Testimony Summaries from Working Group Chairman to
elicit group members to prepare summaries in advance of drafting final
report.
e) Testimony of Jack M. Marco, President, Marco
Consulting Group.
f) Testimony of Samuel W. "Skip" Halpern,
Independent Fiduciary Services, Inc.
g) Written testimony of Christopher Tobe, CFA,
President of the Louisville, Ky., Society of Financial Analysts.
h) Written testimony of Karen L. Barr, General Counsel,
Investment Counsel, Association of America, Inc.
i) "Pros, Cons on Directed Brokerage" news
story on Kenneth L. Kahn, July witness, from September 15, 1997 Pensions
and Investments.
October 8, 1997 Meeting:
a) Agenda
b) *Official Transcript
c) *Executive Summary of Transcript
d) Overview of Witnesses" Recommendations for W.G.
to decide which ones it would include in its final report
e) "A Soft $$ Program Without Performance
Remorse", Wayne Wagner, Plexus Group.
November 13, 1997 Meeting
a) Agenda
b) *Official Transcript
c) *Executive Summary of Transcript
d) Final Report of the Working Group for 1997 (Not
available until it has officially gone forward to the Secretary of Labor.
Anticipate its release the first part of December in hard copy and on the
Internet)
e) Letter from the Association of Investment Management
and Research, dated November 7, 1997, requesting a delay of the W.G.'s
report until it had issued its report on the subject.
VI. 1997 SOFT DOLLAR AND DIRECTED BROKERAGE WORKING
GROUP MEMBERS
James O. Wood, Chairman (11/95-98)
Louisiana State Employees' Retirement System
J. Kenneth Blackwell, Vice Chairman (11/96-99)
Treasurer, State of Ohio
Michael R. Fanning (11/96-99)
Central Pension Fund International
Union of Operating Engineers and Participating
Employees
Carl S. Feen (11/94-97)
CIGNA Financial Advisors
Thomas J. Healey (11/94-97)
Goldman, Sachs & Company
The late Vivian Lee Hobbs (11/95-98)
Arnold and Partner
Marilee P. Lau (11/95-98)
KPMG Peat Marwick, LLP
Dr. Thomas J. Mackell, Jr. (11/96-99)
Simms Capital Management, Inc.
Joyce A. Mader (11/94-97)
O'Donoghue & O'Donoghue
Zenaida M. Samaniego (11/94-97)
Equitable Life Assurance
Society of the United States
Endnote References for Sections I, II and III
<1>"The Morals of the Marketplace - Soft
Dollars and 12;b.1 Fees, Fiduciary Standards Issue (1994).
<2>"News Update, Lynch, Jones & Ryan,
Inc., Feb. 1997, at 5.
<3>Donaldson and Company.
<4>15 U.S.C. § 28(e)(1).
<5>29 U.S.C. §§ 1001-1461.
<6>29 U.S.C. § 1104.
<7>29 U.S.C. § 1106.
<8>"29 U.S.C. § 1104 (a)(1)(A).
<9>Whitfield v. Tomasso, 682 F. Supp. 1287,
1302-3 (E.D.N.Y. 1988).
<10> Jan Twardowski, President of Frank Russell
Securities, Official Transcript (July 16, 1997), at 61.
<11>"Statement on the Future of the
Securities Markets, 37 Fed. Reg. 5286, 5290 (Feb. 4, 1972).
<12>Tina Byles Poitevien, President and Chief
Executive Officer of FIS Funds Management, Inc., Official Transcript (July
17, 1997) at 79.
<13>"Id. at 80.
<14>William Quinn, President of AMR Investment
Services, Official Transcript (May 13, 1997), at 8.
<15>Id.
<16>Id. at 12-13.
<17>Id.
<18>William A. McIntosh, Independent Financial
Consultant, Official Transcript (June 13, 1997) at 62.
<19>Howard J. Schwartz, Chief Executive Officer
of Lynch, Jones & Ryan, Inc., Official Transcript (April 8, 1997) at
31-38.
<20>Tech. Rel. 86-1, Pension and Welfare Benefits
Admin., U.S. Dept. of Labor, May 22, 198
<21>Id.
<22>Kenneth L. Kahn, President and Chief
Operating Officer of Alpha Management, Inc., Official Transcript (July 17,
1997) at 37-38.
<23>Id. at 40-45.
<24>Id. at 45-47.
<25>Id. at 47-49.
<26>Herbert C. Skinner, Jr., President and
Principal of Investment Performance Services, Official Transcript (July
16,1997) at 115-131.
<27>Quinn, at 8.
<28>Id. at 9.
<29>Id. at 11.
<30>Poitevien, at 80.
<31>Quinn, at 11.
<32>Kahn, at 40.
<33>Poitevien, at 81.
<34>Bryce C. Barnes, President of Quantel
Associates, Official Transcript (July 16, 1997) at 100-101.
<35>Id.
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