CSA requests comments on proposed soft-dollar rules

The Canadian Securities Administrators has published proposed rules governing soft-dollar arrangements where advisors use commissions to pay for trading-related goods and services, including incidental advice, research, analytical tools and trade execution.

The proposed National Instrument, Use of Client Brokerage Commissions as Payment for Order Execution Services or Research (“Soft Dollar” Arrangements), reviews responses to past concept papers on the subject, as well as current and proposed rules to govern the arrangements. It also poses questions related to when the rules should be applied or restricted, current practices and use of order-management systems, raw data, post-trade analytics, proxy-voting services, and issues that could arise from proposed disclosure requirements.

Current provisions in place that govern soft-dollar arrangements specify that the only services acquired by managers that can be paid for with client brokerage commissions are “investment decision-making services” and “order execution services” if these benefit clients and not the manager. These services can be provided directly by dealers or third parties.

The February 2005 Concept Paper on the matter suggests soft-dollar arrangement incentives create potential conflicts of interest. Incentives used in such arrangements can obscure an advisor’s best executions obligations since dealers could be selected for their soft-dollar services rather than for the quality of trade execution. Among the 28 comment letters received, the majority believed that regulators should continue to permit commissions to be used as payment for trading-related goods and services and order execution, but said existing provisions were too broad and subjective and asked regulators to spell out exactly which types of goods and services might be allowed under soft-dollar arrangements.

In the U.S., the Securities and Exchange Commission recently narrowed its interpretation of the definitions for brokerage and research services and published a final interpretive release providing guidance on money managers’ use of client commissions to pay for these services. In the U.K., Financial Services Authority rules describe execution and research products and services eligible for payment using commissions and specify a number of non-permitted services that must be acquired using the managers’ own funds.

“The majority of respondents encouraged us to consider the approaches taken in the U.S. and the U.K.,” say the CSA report’s authors. “We have taken into account the SEC and FSA approaches in developing this proposal and believe that it is largely consistent with these approaches.”

Regulators note that there are already fundamental existing obligations for advisors to act fairly, honestly and in good faith with their clients and exercise the degree of care, diligence and skill that a reasonably prudent person would exercise in the circumstances.

The proposed rules provide a framework for the use of commissions, by outlining which goods and services may or may not be acquired using commissions. The rules also discuss which materials are considered to be research and how to determine if materials qualify, provide guidance on mixed-use items that don’t exactly meet existing definitions, and describe how to make reasonable allocations of the amounts paid according to their use. Finally, the instrument prescribes extensive disclosure obligations, record-keeping requirements, and allocation rules for advisors using soft-dollar arrangements.

If enacted, there would be no transition period allowed for firms to adapt their practices. “Existing provisions are in place and the Proposed Instrument and Proposed Policy (simply) provide additional guidance,” say the authors. “Additionally, there will be a period of time between the adoption of any final instrument and its effective date, during which time advisors may make any needed modifications. The most significant modifications will likely be related to the increased disclosure requirements.”

The proposed rules are available for download at regulator’s websites. The submission deadline for written comments is October 19, 2006.

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com