The Securities and Exchange Commission issued guidance last week for fund boards of directors in assessing their firm’s soft-dollar practices. The SEC said it was issuing the guidance a full two years after the limitations it put on soft dollars in 2006, restricting it only to research, due to rapidly evolving market and trading practices. True enough, there are wide discrepancies among brokerages today, due to rapidly evolving markets, trading practices and electronic crossing networks. Fund companies have until Oct. 1 to comment on the SEC’s guidance.

The Commission outlines numerous considerations for boards, which must rely on reports from top management, auditors, counsel and chief compliance officers in assessing day-to-day trading systems.

Previously, boards concerned themselves only with knowing if the trading commissions the investment advisor pays a brokerage buy best execution at the best cost, inclusive of research.

Now they must also ask whether an investment advisor that parses trades among affiliate fund holdings is giving preferential treatment to one portfolio over another. They must also question whether an investment advisor that executes a trade through an affiliated broker/dealer could have gotten a better price, service and research through an outside party.

There are also other factors to consider besides the explicit cost of a trade, of course, these being brokerage commissions, stock exchange fees, taxes and available research. There are implicit costs, as well, for brokers today differ in execution capabilities, trading speed, bid/ask spreads, market impact, anonymity, their own capital they may make available to facilitate a trade, availability of such alternative trading systems as ECNs and dark pools and their relationship with investment advisors. All of this, of course, translates into the great intangible of customer service.

The SEC, most interestingly, tells boards they should find out who negotiates commission rates, how they measure transaction costs, execution-only and research—and how they carry out their negotiations with brokerages.

The SEC is correct to raise these questions. “Is our discussion of the brokerage industry, as relevant to funds and their advisors, accurate?” the SEC asks. This is a golden opportunity for the industry to sound in on the issue.

(c) 2008 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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