Date: February 5, 2007
Description: Use of Commission Payments by Fiduciaries
As of February 12, 2014, this guidance applies to federal savings associations in addition to national banks.*
Purpose and Background
The Securities and Exchange Commission (SEC) issued on July 24, 2006, Release No. 34-54165, Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934 (2006 soft dollar guidance or release). Section 28(e) governs the conduct of all persons who exercise investment discretion with respect to an account, including investment advisers, mutual fund portfolio managers, fiduciaries of bank trust funds, and money managers of pension plans and hedge funds (money managers).
In the release, the SEC revised its previous interpretation1 of "brokerage and research services" as referred to in section 28(e). Section 28(e) provides a "safe harbor" to money managers, including bank fiduciaries, who use the commission dollars of their advised accounts to obtain brokerage and investment research services. Conduct outside of the safe harbor of section 28(e) may constitute a breach of fiduciary duty as well as a violation of specific provisions of the federal securities laws, particularly the Investment Advisors Act of 1940, and for certain accounts, the Employee Retirement Income Security Act of 1974 (ERISA).2
This issuance rescinds TBC-17, dated March 19, 1980, and TBC-25, dated June 19, 1986, which were based upon earlier SEC guidance.
In the 2006 soft dollar guidance, the SEC articulates that the analysis of whether a money manager's acquisition of brokerage and research services with client commissions falls within the section 28(e) safe harbor involves the money manager making a determination using a three-step analytical process. First, the money manager must determine whether the brokerage or research service falls within the specific statutory limits of section 28(e)(3). Second, the manager must determine whether the eligible brokerage or research service provides lawful and appropriate assistance in the investment decision-making process. For "mixed-use" items that are partly eligible and partly ineligible, the release states that a money manager must make a reasonable allocation of client commissions in accordance with the eligible and ineligible uses of the items. Finally, money managers are expected to make a good faith determination that the amount of client commissions paid is reasonable in relation to the value of the brokerage and research services received. The release states that the prudent way for a money manager to meet its burden of showing eligibility for the safe harbor is to document fully its client commission-sharing arrangements.
The release reiterates that money managers may use client commissions to pay only for eligible brokerage and research services. The release states that eligible research services are limited to advice, analyses, and reports under section 28(e). According to the release, when determining whether a product or service is eligible as "research" under section 28(e), the money manager must conclude that it reflects the expression of reasoning or knowledge and relates to the subject matter identified in section 28(e). The release also requires money managers to apply a "temporal" standard to distinguish between eligible and ineligible brokerage services. Under this standard, only brokerage services that relate to the execution of securities transactions and functions incidental thereto that occur between the time an order is transmitted to a broker-dealer and the time funds or securities are delivered or credited to the advised account are eligible for the safe harbor. The release also reiterates that when a product has a mixed use, a money manager must make a reasonable allocation of the cost of the product according to its use, and must keep adequate books and records concerning allocations. The release provides additional guidance and specific examples of eligible and ineligible research and brokerage products and services. Bank fiduciaries should consult the release (attached) for further information.
Third-party Research and Commission-sharing Arrangements
The release also addresses the eligibility criteria of third-party research and commission-sharing arrangements under section 28(e). The release states that the safe harbor is available when a money manager does business with a broker-dealer that is involved in "effecting" the money manager's trades and that also "provides"; the research. According to the release, in order to be "effecting" transactions, the broker-dealer must either execute, clear, or settle the trade, or perform one of four specified functions detailed in the release and allocate the other functions to other broker-dealers. Under the release, the requirement that the broker-dealer "provide" the research is satisfied when the broker-dealer that is effecting transactions for the advised accounts is either legally obligated to pay for the research or pays the research preparer directly and takes steps to see that the services to be paid for with client commissions are within section 28(e).
The 2006 soft dollar guidance became effective on July 24, 2006. However, money managers, including bank fiduciaries, were able to rely on prior SEC guidance until January 24, 2007.
For more information, contact Asset Management at (202) 649-6360.
Director for Credit and Market Risk
1 1986 SEC Interpretive Release 34-23170, Sections II and III. This release does not replace other sections of the 1986 release.
2 ERISA Technical Release 86-1 contains the Department of Labor's current guidance on the proper use of soft dollars.
* References in this guidance to national banks or banks generally should be read to include federal savings associations (FSA). If statutes, regulations, or other OCC guidance is referenced herein, please consult those sources to determine applicability to FSAs. If you have questions about how to apply this guidance, please contact your OCC supervisory office.