[Federal Register Volume 60, Number 34 (Tuesday, February 21, 1995)]
[Proposed Rules]
[Pages 9750-9759]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-4160]




[[Page 9749]]

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Part IV





Securities and Exchange Commission





_______________________________________________________________________



17 CFR Parts 275 and 279



Disclosure By Investment Advisers Regarding Soft Dollar Practices; 
Proposed Rule

Federal Register / Vol. 60, No. 34 / Tuesday, February 21, 1995 / 
Proposed Rules 
[[Page 9750]] 

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 275 and 279

[Release No. 34-35375; IA-1469; S7-5-95]
RIN 3235-AG36


Disclosure by Investment Advisers Regarding Soft Dollar Practices

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule and form.

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SUMMARY: The Commission is proposing for comment a new rule and form 
under the Investment Advisers Act of 1940 that would require certain 
investment advisers to provide clients with an annual report regarding 
their use of client brokerage. The proposed report would include 
disclosure about an adviser's use of its clients' brokerage commissions 
during the previous year, including information about research and 
other services obtained by the adviser with those commissions. The 
proposed annual report is intended to provide investment advisory 
clients with important information about the brokerage commissions they 
pay and their advisers' receipt of ``soft dollar'' benefits from those 
commissions.

DATES: Comments should be received on or before May 19, 1995.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, 
N.W., Washington, D.C. 20549. All comment letters should refer to File 
No. S7-5-95. All comments received will be available for public 
inspection and copying in the Commission's Public Reference Room, 450 
Fifth Street, N.W., Washington, D.C. 20549.

FOR FURTHER INFORMATION CONTACT: Eric C. Freed, Special Counsel, or 
Robert E. Plaze, Assistant Director, (202) 942-0721, Office of 
Disclosure and Investment Adviser Regulation, Division of Investment 
Management, Securities and Exchange Commission, 450 Fifth Street, N.W., 
Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission today 
is proposing for comment:
    (1) rule 204-4 (17 CFR 275.204-4) under the Investment Advisers Act 
of 1940 (15 U.S.C. 80b-1 et seq.) (``Advisers Act''), which would 
require an investment adviser registered or required to be registered 
under the Advisers Act to deliver to its clients an annual report on 
the adviser's direction of client brokerage transactions and its 
receipt of research and other services in connection with those 
transactions; and
    (2) Form ADV-B under the Advisers Act, which would set forth the 
information required to be included in the annual report.

Executive Summary

    The Commission is proposing a new rule and form under the Advisers 
Act to require each investment adviser (``adviser''), registered or 
required to be registered under the Advisers Act, that has the 
discretion to direct client brokerage transactions and receives 
services other than execution in exchange for that brokerage, to 
provide its clients with a report that would contain information about 
its use of client brokerage. The report would disclose for the 
adviser's most recently completed fiscal year, (1) the twenty brokers 
to which the adviser directed the largest amounts of commissions and 
certain other transaction-related payments (collectively, 
``commissions''), (2) the three brokers substantially all of whose 
services for the adviser were execution services (``execution-only 
brokers'') to which the adviser directed the largest amounts of 
commissions, (3) the aggregate amount of commissions directed by the 
adviser to each broker listed and the percentage of the adviser's total 
discretionary brokerage this amount represents, (4) the average 
commission rate paid to each broker listed, and (5) for each broker 
other than an execution-only broker, information concerning products or 
services obtained from the broker. The report would also disclose the 
percentages of the adviser's total commissions that are directed to 
execution-only brokers, to other brokers, and at the request of 
clients. The report would require only information about an adviser's 
use of client brokerage on an aggregate basis; it would not require 
separate information about the brokerage of the adviser's various 
clients. The report would be provided to existing advisory clients 
annually and to prospective advisory clients no later than the time 
that an advisory agreement is entered into.

I. Background

    Soft dollar practices are arrangements under which products or 
services other than execution of securities transactions (``soft dollar 
services'') are obtained by an adviser from or through a broker in 
exchange for the direction by the adviser of client brokerage 
transactions to the broker.\1\ Soft dollar practices are common in the 
institutional brokerage market. According to an informal annual survey 
of investment advisers and other institutions, nearly ninety percent of 
these institutions engage in soft dollar arrangements, and more than 
forty percent of commissions are directed primarily for the purpose of 
obtaining research services.\2\

    \1\See Securities Exchange Act Rel. No. 23170 (Apr. 23, 1986) 
[51 FR 16004 (Apr. 30, 1986)] (``Release 23170'') at Sec. I; Robert 
J. Moran & Cathy G. O'Kelly, Soft Dollars and Other Traps for the 
Investment Adviser, 1 DePaul Bus. L.J. 45, 45 n.5 (1989).
    \2\Greenwich Associates, Soft-Dollars: Opportunities and 
Challenges (special presentation of May 10, 1994); Greenwich 
Associates, Institutional Equity Investors 1994 (statistical supp.) 
3, 17.
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    Soft dollar practices originally developed as a means by which 
brokers provided discounts on brokerage commissions that were fixed 
pursuant to exchange and commission rules. In 1975, the Commission 
prohibited fixed commission rates\3\ and, later that year, Congress 
codified the Commission's action.\4\ After the Commission abolished 
fixed rates, concerns were raised whether the soft dollar practices 
that had developed in the context of fixed rates would continue to be 
consistent with various state and federal laws, including the Advisers 
Act.\5\

    \3\Securities Exchange Act Rel. No. 11203 (Jan. 23, 1975) (40 FR 
7394 (Feb. 20, 1975)).
    \4\Securities Acts Amendments of 1975, Pub. L. No. 94-29, 89 
Stat. 97, 107-08 (enacting Section 6(e)(1) of the 1934 Act (15 
U.S.C. 78f(e)(1))).
    \5\S. Rep. No. 75, 94th Cong., 1st Sess. 70 (1975).
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    Underlying these concerns is an adviser's fundamental obligation 
under the Advisers Act (and state law) to act in the best interest of 
its clients.\6\ This duty requires the adviser to obtain best execution 
of client transactions,\7\ and precludes the adviser from using client 
assets for its own benefit or the benefit of other clients, at least 
without client consent.\8\ Upon the Commission's eliminating fixed 
commission rates, some argued that an adviser could be deemed to have 
violated this duty if the adviser caused a client's account to pay 
anything but the lowest commission rates. If this view was upheld, soft 
dollar arrangements could have been effectively precluded by the 
decision to eliminate fixed commission rates.

    \6\See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 
194 (1963).
    \7\Delaware Management Co., 43 S.E.C. 392, 396 (1967). An 
adviser is obligated to use reasonable diligence to select a broker 
who will ``execute securities transactions for clients in such a 
manner that the client's total cost or proceeds in each transaction 
is most favorable under the circumstances.'' Securities Exchange Act 
Rel. No. 23170 (Apr. 23, 1986) [51 FR 16004 (Apr. 30, 1994)] 
(``Release 23170'') at Sec. V (citing Kidder, Peabody & Co., 43 
S.E.C. 911, 915 (1968)). An adviser should consider the full range 
and quality of the broker's services, including the value of 
research received, in assessing whether a broker will provide best 
execution. Id.
    \8\Restatement (Second) of Trusts Sec. 170 comment a, Sec. 216 
(1959). [[Page 9751]] 
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    Congress, in codifying the abolition of fixed commission rates, 
responded to these concerns by enacting Section 28(e) of the Securities 
Exchange Act of 1934 (the ``1934 Act'') [15 U.S.C. 78bb(e)], which 
provides a safe harbor for certain soft dollar arrangements.\9\ Section 
28(e) provides, in pertinent part, that an adviser with investment 
discretion over an account will not be deemed to have acted unlawfully 
or to have breached its fiduciary duty by causing the account to pay a 
higher commission to a broker that provides research benefiting the 
adviser's accounts. To rely on the Section 28(e) safe harbor, an 
adviser must determine in good faith that the commissions paid are 
reasonable in relation to the value of the brokerage and research 
services provided, either in terms of the particular transaction or the 
adviser's overall responsibilities towards its discretionary 
accounts.\10\

    \9\Securities Acts Amendments of 1975, Pub. L. No. 94-29, 89 
Stat. 97, 161-62.
    \10\The Commission has stated that a product or service may 
legitimately be considered a ``brokerage or research service'' 
covered by the safe harbor if it provides ``lawful and appropriate 
assistance to the [adviser's] decision-making process.'' Release 
23170, supra note 1. The Commission's Division of Market Regulation 
has addressed the types of transactions that are afforded the 
protection of the safe harbor. See U.S. Department of Labor (pub. 
avail. July 25, 1990) (safe harbor does not extend to principal, 
riskless principal and futures transactions); Hoenig & Co. (pub. 
avail. Oct. 15, 1990) (same); Instinet Corporation (pub. avail. Jan. 
15, 1992) (safe harbor does apply to agency transactions in equity 
securities on a computer-based real time market information and 
brokerage system and after-hours order matching system).
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    Section 28(e) modifies a fiduciary's strict duty to act in the best 
interest of each client with respect to the management of each client's 
assets. Thus, it permits an adviser to cause a client to pay higher 
commissions than otherwise are available to obtain research that may 
not be used exclusively for the benefit of the client or used to 
benefit the client at all. Section 28(e), however, does not afford a 
safe harbor with respect to all conflicts of interest between the 
adviser and its clients that may arise from soft dollar arrangements. 
For example, soft dollar arrangements may cause an adviser, in order to 
obtain soft dollar services, to violate its best execution obligations 
by directing client transactions to brokers who could not adequately 
execute the transactions. Soft dollar arrangements also may give 
advisers incentives to trade client securities inappropriately to 
generate credits for soft dollar services.\11\

    \11\See Securities and Exchange Commission v. Galleon Capital 
Management, Litigation Rel. No. 14315 (Nov. 1, 1994). The 
Commission's complaint in Galleon, in addition to alleging excessive 
trading in order to generate soft dollar credits, alleged that the 
adviser requested brokers to make soft dollar payments to a 
consulting firm, and that these payments eventually were rebated to 
the adviser. See also Letter from Bradford P. Schaaf, Chairman, and 
Victor J. Fontana, President and Chief Executive Officer, Autranet, 
Inc. to Barry P. Barbash, Director, Division of Investment 
Management and Brandon Becker, Director, Division of Market 
Regulation (Nov. 10, 1994) (``Autranet Letter'') (proposing that the 
Commission prohibit a broker from requiring an adviser, by contract 
or understanding, to commit to direct any specified amount of 
commissions to the broker in order to receive soft dollar services).
    Soft dollar practices also diminish the ability of a client to 
evaluate the expenses it incurs in obtaining portfolio management 
services and may hinder the ability of the client to negotiate fee 
agreements, because the costs of soft dollar services are ``hidden'' 
from investors in brokerage commissions. By permitting advisers to use 
their clients' transactions to pay for research services that they 
otherwise would have to purchase with ``hard dollars,'' soft dollar 
arrangements permit advisers to charge fees that do not fully reflect 
the cost of portfolio management. Advisers that do not engage in soft 
dollar arrangements may be put at a competitive disadvantage if they 
pay for services with hard dollars and attempt to pass the cost of 
these services on to clients through higher fees.
    Congress recognized the conflicts that soft dollar practices 
present and provided in section 28(e) authority for the Commission to 
require advisers to disclose to their clients their policies and 
practices with respect to the use of client commissions.\12\ The 
Commission has never adopted rules under section 28(e),\13\ but has 
instead required certain disclosure in Part II of Form ADV, which 
specifies the content of the disclosure document or ``brochure'' that 
an adviser is required to provide to clients before entering into 
advisory relationships.\14\ If soft dollar arrangements are a factor in 
selecting brokers to effect client transactions, the brochure must 
disclose the nature of the adviser's soft dollar practices, including: 
(i) the services that the adviser obtains through soft dollar 
arrangements; (ii) whether clients may pay higher commissions (``pay 
up'') as a result of the arrangements; (iii) whether soft dollar 
services are used to benefit all client accounts or only those accounts 
the brokerage of which was used to purchase the services; and (iv) any 
procedures that the adviser uses to allocate brokerage.\15\

    \12\Section 28(e)(2) (15 U.S.C. 78bb(e)(2)).
    \13\In 1976, the Commission proposed rule 28e2-1 under the 1934 
Act, but the rule was never adopted. See note 41 infra.
    \14\Rule 204-3 under the Advisers Act (17 CFR 275.204-3) 
requires that a registered investment adviser deliver the brochure 
to a prospective client before entering into an advisory contract 
with the client, and, annually thereafter, provide or offer to 
provide the client with the brochure. The Commission is not at this 
time proposing to amend the Form ADV requirements regarding 
disclosure of soft dollar arrangements. The Commission, however, is 
considering whether changes to these requirements would be 
appropriate, and may propose changes in connection with future 
revisions to Form ADV.
    \15\Item 12 of Part II of Form ADV. Registered investment 
companies are required to include similar disclosure in their 
Statements of Additional Information. See, e.g., Item 17 of Form N-
1A (17 CFR 239.15A, 274.11A).
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    Two broker-dealers, Goldman, Sachs & Co. and Morgan Stanley Group 
Inc., themselves providers of research services to advisers, have 
strongly criticized the effectiveness of current disclosure 
requirements.\16\ Current disclosure primarily focuses on the policies 
and practices that the adviser intends to follow with respect to the 
use of client brokerage.\17\ This disclosure does not, Goldman, Sachs 
and Morgan Stanley assert, adequately disclose to clients the extent to 
which an adviser has soft dollar commitments or the specific benefits 
that accrue to the adviser from the use of the client brokerage. These 
brokers have proposed that the Commission adopt a requirement that 
advisers periodically report to clients the soft dollar benefits that 
they have received and the specific value of those benefits, as well as 
certain information about how the brokerage of each client was directed 
(the ``Goldman/Morgan Proposal'').\18\ Other participants in soft 
dollar arrangements, organized by the Alliance in Support of 
Independent Research, have argued that current client disclosure by 
advisers is adequate and that the Goldman/Morgan Proposal is 
anticompetitive and discriminatory.\19\

    \16\See Future of the Stock Market: Soft Dollars, Hearing Before 
the Subcomm. on Telecommunications and Finance of the House Comm. on 
Energy and Commerce, 103d Cong., 1st Sess. (1993) (``1993 
Hearings'') (testimony of David M. Silfen, Partner, Goldman, Sachs & 
Co. and Anson M. Beard, Jr., Managing Director, Morgan Stanley Group 
Inc.).
    \17\The Commission has instituted a number of enforcement 
actions against advisers based, at least in part, on the failure to 
disclose soft dollar arrangements adequately. See, e.g., Securities 
and Exchange Commission v. Galleon Capital Management, supra note 
11; Kingsley, Jennison, McNulty & Morse, Inc., Investment Advisers 
Act Rel. No. 1396 (Dec. 23, 1993); DeMarche Associates, Investment 
Advisers Act Rel. No. 1392 (Nov. 23, 1993); Jack Allen Pirrie, 
Investment Advisers Act Rel. No. 1284 (July 29, 1991); Robert 
Michael Lee, Investment Advisers Act Rel. No. 1249 (Sept. 17, 1990); 
Patterson Capital Corp., Investment Advisers Act Rel. No. 1235 (June 
25, 1990).
    \18\The Goldman/Morgan Proposal will be placed in the public 
comment file for the Commission's proposal.
    \19\See Letter from The Alliance in Support of Independent 
Research to Jonathan G. Katz, Secretary, Securities and Exchange 
Commission (Oct. 17, 1994), Commission File No. S7-22-94 (``Alliance 
Letter''); see also Autranet Letter, supra note 11. The Alliance in 
Support of Independent Research is ``a group of broker-dealers, 
money managers and research firms sharing a common interest in 
fostering a favorable regulatory environment in which independent 
research services and products may be furnished to the money 
management community.'' [[Page 9752]] 
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    The difference in the views of these two groups may reflect the 
differences in the ways the two groups provide research services to 
advisers and the effect that the Goldman/Morgan Proposal would have on 
each group. Goldman, Sachs and Morgan Stanley operate as ``full service 
brokers'' and provide a variety of execution, research and related 
services to clients. An adviser who executes client securities 
transactions through these firms typically receives research services 
developed by the firms (``proprietary'' soft dollar services), much of 
which is provided without being directly requested by the adviser. The 
cost of such services generally are bundled in the overall commission 
charged by the full service broker. In contrast, a ``soft dollar 
broker'' typically provides advisers with services prepared or produced 
by parties other than the broker (``third-party'' soft dollar services) 
in exchange for the allocation of specified amounts of commission 
dollars.\20\ In these types of arrangements, an explicit price 
denominated in commission dollars, rather than in hard dollars, is 
typically attached to the research.\21\

    \20\In 1980, the Commission stated that research provided 
through third-party arrangements falls within Section 28(e) of the 
Exchange Act, even if the money manager participates in selecting 
the research services provided to it and the research is delivered 
directly to the money manager by the third party. Securities 
Exchange Act Rel. No. 17371 (Dec. 12, 1980) (45 FR 83707 (Dec. 19, 
1980)). The Section 28(e) safe harbor is not available to third-
party soft dollar arrangements unless, among other things, the 
broker is obligated to the third party to pay for the services. 
Release 23170, supra note 1, at Sec. III; Kingsley, Jennison, 
McNulty & Morse, Inc., supra note 17.
    \21\Some full service brokers also will enter into third-party 
soft dollar arrangements with advisers.
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    The Goldman/Morgan Proposal would affect the two groups of brokers 
differently. Because proprietary soft dollar services are not offered 
for a specific price in commission dollars, under the Goldman/Morgan 
Proposal, disclosure would be required only about the price and value 
of third-party soft dollar services. Soft dollar brokers argue that if 
the Commission required more extensive disclosure of third-party soft 
dollar services than proprietary soft dollar services, advisory clients 
might be led to believe that advisers derive benefits from soft dollar 
brokers at the clients' expense that they do not derive from full 
service brokers, when, in fact, both types of firms confer benefits on 
advisers.\22\ As a result, advisers might be discouraged from using 
soft dollar brokers.

    \22\See Alliance Letter, supra note 19.
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    Representatives of some investment advisers have asserted that 
current disclosure requirements are adequate.\23\ According to these 
advisers, clients rarely request information about the soft dollar 
benefits that the adviser receives, and those that are interested 
currently may obtain the information on request.\24\ Other investment 
advisers, however, argue that the nature of the conflicts involved in 
soft dollar arrangements warrant more extensive client disclosure than 
is currently required.\25\

    \23\See, e.g., 1993 Hearings, supra note 16 (statement of Holly 
A. Stark, Senior Vice President, Dalton, Greiner, Hartman, Maher & 
Co.).
    \24\Many pension plans require some form of soft dollar 
reporting from their money managers, primarily in response to a 
pronouncement of the Department of Labor, the principal federal 
regulator of employee benefit plans under the Employee Retirement 
Income Security Act of 1974 (``ERISA''), concerning the ongoing duty 
of plan fiduciaries to monitor the use of soft dollars by managers. 
See ERISA Technical Release No. 86-1.
    Section 15(c) of the Investment Company Act of 1940 (15 U.S.C. 
80a-15(c)) requires the directors of a registered investment company 
to request and review, and the company's adviser to supply, such 
information as may reasonably be necessary to evaluate the terms of 
the advisory contract between the adviser and the investment 
company. As discussed above, soft dollar arrangements may bear upon 
the reasonableness of advisory fees. See text accompanying note 12 
supra. Investment company advisers that engage in soft dollar 
arrangements therefore must provide their boards of directors with 
information regarding soft dollar arrangements. See Release 23170, 
supra note 1, at Sec. IV.B.3.
    Various institutional investors have expressed their views on 
soft dollar arrangements. See 1993 Hearings (statement of Fred G. 
Weiss, Chairman, Financial Executive Institute's Committee on 
Investment of Employee Benefit Assets (``CIEBA'')). Mr. Weiss stated 
that CIEBA, which represents 150 corporate benefit plan sponsors 
with assets of approximately $600 billion, was unable to develop a 
clear consensus on whether soft dollar practices were desirable or 
not. CIEBA did, however, call for more comprehensive reporting of 
soft dollar arrangements at a firm-wide level to supplement the 
client-specific information that most of its members currently 
receive. Other institutional investors believe that current 
disclosure is adequate. See 1993 Hearings (written statement of 
State Board of Administration of Florida). In addition, the 
Institutional Investors Committee of the National Association of 
Securities Dealers, Inc. (``NASD Committee''), which includes 
representatives of institutional investors, advisers, and brokerage 
firms, submitted a recommendation to the Commission's staff for 
additional soft dollar disclosure. The NASD Committee's 
recommendation was approved by the NASD's Board of Governors. The 
NASD Committee's recommendation will be placed in the public comment 
file for the Commission's proposal.
    \25\See Letter from Louis R. Cohen and Marianne K. Smythe, 
Wilmer, Cutler & Pickering to Jonathan G. Katz, Secretary, 
Securities and Exchange Commission (Oct. 17, 1994) (on behalf of 
Investors Research Corp.) (``Investors Research Letter''), 
Commission File No. S7-22-94.
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    The Commission staff considered issues related to soft dollars in 
its ``Market 2000'' report on the equity markets released in January 
1994.\26\ In that report, the staff recommended that quantifiable 
information about soft dollar services be required to be provided to 
advisory clients.\27\ The report also stated that ``[m]ost importantly 
* * * any new disclosure requirements should apply equitably. Thus, 
research and other services obtained either from (full service) firms 
or (soft dollar) firms should be subject to disclosure.''

    \26\See U.S. Securities and Exchange Commission, Division of 
Market Regulation, Market 2000: An Examination of Current Equity 
Market Developments (Jan. 1994).
    \27\Id. at V-15.
II. Discussion

    The Commission believes that, in light of the conflicts of interest 
presented by soft dollar arrangements, additional disclosure about 
these practices may be warranted. While current disclosure may provide 
sufficient notice to a client that the adviser has these conflicts, it 
may not provide the client with sufficient information to permit it to 
assess the extent to which the adviser obtains soft dollar services or 
pays up for those services, or the types of services that the adviser 
obtains through soft dollar arrangements. Enhanced disclosure may 
provide existing clients with information useful in negotiating limits 
on the use of their brokerage, and enable prospective clients to make 
better informed choices of advisers.
    The Commission is therefore proposing that certain registered 
advisers be required to provide clients with annual reports setting 
forth certain information about their use of client brokerage and the 
soft dollar services each adviser received during its most recently 
completed fiscal year.<SUP>28 The proposal is intended to provide an 
advisory client with information that can be used to evaluate the 
extent to which the client benefits from the adviser's brokerage 
practices, the extent to which the adviser benefits, and whether the 
client should attempt to limit the adviser's use of its brokerage. 
Consistent with the recommendations of the staff in the Market 2000 
report, the proposed disclosure requirements would not impose different 
[[Page 9753]] requirements on third-party and proprietary soft dollar 
arrangements.

    \28\The proposed amendments would not require that advisers 
provide each client with information about how that client's 
transactions were directed. See Section II.F infra.
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A. The Annual Report in General

    The Commission is proposing a new rule under the Advisers Act, rule 
204-4, that would require any adviser, registered or required to be 
registered under the Advisers Act, that has brokerage discretion<SUP>29 
over any client account and that receives soft dollar services to 
deliver an annual report to clients on its use of client brokerage. The 
contents of the annual report would be specified in new Form ADV-B.

    \29\The definition of ``brokerage discretion'' is discussed at 
notes 58-59 and accompanying text infra.
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    The core of the annual report would be a table disclosing 
information regarding the adviser's direction of client brokerage. The 
table would list the twenty brokers other than execution-only brokers 
(``research brokers'') to which the adviser directed the greatest 
amount of client commissions,<SUP>30 and the three execution-only 
brokers to which the adviser directed the greatest amount of client 
commissions during its most recent fiscal year.<SUP>31 For each broker 
listed, the table would disclose: the aggregate amount of commissions 
directed by the adviser to the broker; the percentage of the adviser's 
discretionary brokerage commissions that this represents; the average 
commission rate (in cents per share) paid to the broker; and a 
description of the soft dollar services provided by the broker.<SUP>32

    \30\For the purposes of the amendments, ``commissions'' would 
include amounts of mark-ups and mark-downs on principal transactions 
if those amounts are included on the confirmation of the transaction 
required under rule 10b-10 under the 1934 Act. See Section II.E 
infra. These mark-ups and mark-downs, however, are not commissions 
for purposes of Section 28(e). See note 10 supra.
    \31\The definition of ``execution-only broker'' is discussed at 
notes 36-38 and accompanying text infra.
    \32\Items 2-3 of proposed Form ADV-B. For purposes of 
determining the amount of commissions and the corresponding 
percentage of the adviser's discretionary brokerage that this amount 
represents, sales loads on transactions in investment company shares 
would be considered commissions. Because sales loads typically are 
not calculated on a cents per share basis and could potentially 
distort the average commission rate data, sales loads would not be 
considered in calculating average commission rates. Instruction 3 to 
Item 2 of proposed Form ADV-B.
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    The table would provide an overview of the brokers used by an 
adviser to execute client transactions, the commissions charged by the 
brokers, and the soft dollar services received from research brokers. 
This disclosure is intended to assist an advisory client in evaluating 
the adviser's use of its brokerage, including whether the client could 
be paying lower commissions, whether the adviser is obtaining soft 
dollar services that can be used to benefit the client, and whether the 
advisory fee charged to the client is appropriate in light of the 
services that the adviser pays for with client commissions. 
Institutional clients using the services of more than one adviser and 
prospective clients considering different advisers will be able to use 
the table to compare advisers' use of brokerage, including the 
commission rates that they negotiate and the types of services that 
they receive. The disclosure regarding execution-only brokers would 
assist clients in making these determinations by providing information 
about the availability of brokerage alternatives, and, by implication, 
the effect that soft dollar services may have on commission 
rates.<SUP>33

    \33\The Commission recognizes that the use of execution-only 
brokers would not be appropriate or possible in many circumstances. 
The proposed disclosure about execution-only brokers is not intended 
to imply that such brokers could have been used in all 
circumstances. Furthermore, an adviser would be permitted to explain 
its policies regarding the use of execution-only brokers in a 
narrative portion of the annual report. See General Instruction 6 to 
Proposed Form ADV-B.
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    The table would be followed by certain data concerning the 
adviser's direction of brokerage: the percentages of the adviser's 
total brokerage that are directed (1) by the adviser to research 
brokers, (2) by the adviser to execution-only brokers, and (3) pursuant 
to specific client instructions.<SUP>34 This data would provide clients 
with an overall picture of how the adviser directs brokerage.

    \34\Item 4 of proposed Form ADV-B.
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B. Disclosure of Brokers

    As noted above, the report would be required to include information 
about twenty research brokers and three execution-only brokers.<SUP>35 
Limiting the required disclosure to this number of brokers is intended 
to result in reports that provide useful information in a relatively 
concise manner. Comment is requested whether the proposed numerical 
thresholds are appropriate. Comment is also requested whether, as an 
alternative, disclosure should be required about brokers to which the 
adviser directed more than a specified percentage of its brokerage, 
such as one percent.

    \35\For purposes of the annual report, a ``broker'' would 
include a bank that is not registered as a broker-dealer under the 
1934 Act. Instruction 1 to Item 2 of proposed Form ADV-B.
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    For the purposes of the amendments, a broker would be considered an 
``execution-only'' broker if substantially all of the services that the 
broker provides to the adviser are execution services, i.e., effecting 
securities transactions and performing functions incidental to or 
required in connection with effecting those transactions.<SUP>36 
Consequently, a broker would not be permitted to be considered an 
execution-only broker if it provided any significant amount of soft 
dollar services to the adviser, even if the services were not solicited 
or used by the adviser.<SUP>37 If a broker provided only execution 
services to an adviser, however, the adviser would include the broker 
as execution-only even if the broker provided additional services, such 
as research, to its other customers. The definition of execution-only 
broker would include automated trading systems (e.g., the Instinet and 
Lattice systems) if the adviser received only execution and execution-
related services as a result of using the system, regardless of whether 
the system itself is required to be registered as a broker-dealer under 
the 1934 Act.<SUP>38

    \36\Instruction to Item 3 of proposed Form ADV-B. The definition 
of execution-only broker is derived from Section 28(e)(3)(C) of the 
1934 Act [15 U.S.C. 78bb(e)(3)(C)]. Under that section, custody of 
securities is a function incidental to effecting a transaction in 
the securities.
    \37\A broker would be permitted to be considered an execution-
only broker if it provided a minimal amount of soft dollar services 
to the adviser, such as a single research report or a single contact 
with a securities analyst.
    \38\Instruction to Item 3 of proposed Form ADV-B. Typically, the 
sponsor of an automated trading system will be required to be 
registered as a broker-dealer under the 1934 Act. An automated 
trading system would be included in the definition of broker in Form 
ADV-B if a fee is charged for using the system, regardless of the 
basis for the fee (e.g., a flat usage fee or transaction-based 
fees).
    An adviser that did not utilize any research brokers or that did 
not utilize any execution-only brokers would be required to so state 
under the appropriate heading in the table.<SUP>39 An adviser that 
directed client commissions to fewer than twenty research brokers and/
or fewer than three execution-only brokers would be required to 
disclose under the appropriate headings those brokers to which it did 
direct client commissions. As a result, an adviser's annual report 
would always include some reference to the existence of execution-only 
brokers. Comment is requested whether there are better ways to disclose 
to clients the availability and cost of brokerage alternatives. For 
instance, comment is requested whether an adviser should be required to 
disclose execution-only brokers that offered to execute client 
transactions. Similarly, comment is requested whether the table should 
include [[Page 9754]] disclosure regarding all brokers used by the 
adviser.<SUP>40

    \39\Items 2 and 3 of proposed Form ADV-B.
    \40\In order to keep the report at a manageable length, an 
adviser could be permitted merely to indicate whether or not it 
received soft dollar services, rather than to identify the services 
received, from brokers that were not among those it used most 
frequently (e.g., the top twenty).
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    Comment is requested generally on the definition of an execution-
only broker, and whether the proposal's classification of brokers into 
two types, execution-only and all others, is appropriate or 
practicable. Instead of classifying brokers by type, the Commission 
considered proposing that advisers be required to classify brokers or 
specific trades based upon the purposes for which the trades were 
directed to the broker (e.g., execution or research). Under this 
approach, trades directed to a broker that provided soft dollar 
services could be considered to be directed for the purposes of 
execution if the services were a minimal factor in directing the 
brokerage. The Commission is not proposing this approach because 
determining the purposes for which brokers are used or individual 
trades are directed may be impracticable and burdensome.<SUP>41 The 
proposed approach, which would not permit an adviser to treat a broker 
from whom it receives significant soft dollar services as an execution-
only broker, seeks to reduce the burden on advisers by providing a more 
objective basis for classifying brokers. Nevertheless, comment is 
requested whether the annual report should require advisers to classify 
brokers or trades by the purposes for which the adviser directed the 
brokerage.

    \41\In 1976, the Commission proposed rule 28e2-1 under the 1934 
Act, which would have required advisers to make certain disclosures 
to clients concerning soft dollar practices in a separate annual 
report. Securities Exchange Act Rel. No. 13024 (Nov. 30, 1976) (41 
FR 53356 (Dec. 6, 1976)). The proposed rule, which was not adopted, 
would have required, among other things, narrative disclosure 
concerning research received ``in return for'' brokerage. Commenters 
stated that it was impracticable to determine whether research was 
obtained ``in return for'' specific services, particularly when the 
research was not solicited. See Securities Exchange Act Rel. No. 
10569 (Jan. 30, 1979) (44 FR 7864 (Feb. 7, 1979)) (``Release 
10569'').
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C. Disclosure of Products and Services Received

    The annual report would describe the soft dollar services received 
by the adviser from each research broker listed. Except as discussed 
below, soft dollar services would be required to be identified 
specifically.<SUP>42 The producer of a third-party soft dollar service 
would be identified unless its name was evident from the name of the 
product. This information is intended to permit a client to assess 
whether it benefits from the soft dollar services that the adviser 
receives and, consequently, whether it should attempt to limit the 
adviser's use of its brokerage.

    \42\Instruction 7 to Item 2 of proposed Form ADV-B.
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    In many cases, an adviser receives research reports from a broker 
or is given access to the broker's securities professionals in exchange 
for the direction of brokerage. An adviser would not be required to 
list separately every report that it received or each professional with 
whom it had contact. Instead, an adviser would be permitted to refer to 
these services generically according to the following categories: (1) 
Analyses and reports on specific securities, issuers or industries, (2) 
political or economic analyses or reports, or (3) access to securities 
analysts.<SUP>43 All other services, including computer hardware, 
software, databases, and on-line services, financial or other 
publications available by subscription, and any products or services 
falling outside the scope of Section 28(e) of the 1934 Act, would be 
required to be identified specifically.

    \43\Id.
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    Comment is requested whether soft dollar services should be 
identified in this manner. Should the Commission require more specific 
disclosure of research reports or access to securities analysts or 
other professionals, or permit general descriptions of other services? 
Comment is requested whether, either in lieu of or in addition to 
separate identification of the services received, soft dollar services 
should be required to be classified into specified categories, and, if 
so, what those categories should be.<SUP>44

    \44\In connection with its annual survey of institutions 
regarding their brokerage practices, see note 2 and accompanying 
text supra, Greenwich Associates uses the following nine categories 
of soft dollar services: performance measurement, third-party 
research, corporate fundamental databases, technical analysis 
software, portfolio modeling and strategy software, on-line stock 
price quotations, specialized political or economic analyses, 
terminals and computers, and custody services. Greenwich Associates, 
Institutional Equity Investors 1994 (statistical supp.) 19.
---------------------------------------------------------------------------

    In addition to requiring a description of the soft dollar services 
received, the Goldman/Morgan Proposal would have required that an 
adviser disclose the price in commission dollars and fair market value 
of each third-party soft dollar service (which typically will be 
provided at an explicit price). As noted above, the Goldman/Morgan 
proposal would not require this disclosure regarding proprietary soft 
dollar services, as these services are not explicitly assigned a price. 
Price and fair value information may be useful as an expression of the 
value of the soft dollar services obtained by the adviser.<SUP>45 The 
Commission is concerned, however, that unless the values of proprietary 
soft dollar services are also included in the report, the information 
provided to the client would be incomplete and may distort client 
understanding about the benefits that advisers receive through client 
brokerage. Clients, for example, may incorrectly believe that soft 
dollar services are not a consideration in an adviser's direction of 
client brokerage to full service brokers or that third-party soft 
dollar services are of greater value (either to advisers or clients) 
than proprietary soft dollar services. Moreover, the Goldman/Morgan 
Proposal may provide an investment adviser an incentive to direct 
brokerage to a full service broker rather than a soft dollar broker for 
the same types of soft dollar services, simply because of differing 
client reporting requirements. This consequence may not be in the best 
interests of advisory clients and may be unfair to soft dollar brokers. 
Thus, consistent with the staff's recommendations in the Market 2000 
report, the Commission is not proposing that only third-party soft 
dollar services be valued.

    \45\The Commission recently proposed that estimates of the value 
of non-monetary payments for order flow be disclosed to customers of 
brokers receiving such payments. Securities Exchange Act Rel. No. 
34903 (Oct. 27, 1994) (59 FR 55014 (Nov. 2, 1994)). Payment for 
order flow is payment by a broker, dealer, securities exchange, 
securities association or exchange member to a broker or dealer in 
return for the routing of customer orders to the broker, dealer, 
securities exchange, securities association, or exchange member.
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    The Commission also considered requiring advisers to report the 
fair market value of all soft dollar services, regardless of their 
source. Because there often is no agreed upon price for proprietary 
soft dollar services, their fair market value may not readily be 
ascertainable. One approach might be to require advisers to disclose 
the cost to the broker of producing proprietary soft dollar services. 
The cost of producing services, however, may not reflect their fair 
market value, and an adviser may not be able to verify cost information 
provided by brokers.<SUP>46 Alternatively, the value of soft dollar 
services to the adviser receiving them could be [[Page 9755]] required 
to be disclosed, but it may be inappropriate and misleading to reflect 
services that the adviser did not solicit or use as having no 
value.<SUP>47

    \46\In addition, it is unclear how a broker's ``cost'' should be 
determined. An ``average cost'' could be obtained by dividing the 
cost of producing the services by the number of recipients. 
``Marginal cost'' would measure the actual cost of providing the 
research to the last adviser. Full service brokers frequently 
distribute to advisers and other customers research services that 
were initially produced for other purposes. The marginal cost of 
such research might be only the cost of its distribution.
    \47\An adviser could be required to report only those 
proprietary soft dollar services for which it specifically directed 
brokerage. Such a limitation, however, would require highly 
subjective determinations by advisers, and, as a practical matter, 
might elicit disclosure about only third-party soft dollar services.
---------------------------------------------------------------------------

    An adviser could be required to make a good faith estimate of what 
the proprietary soft dollar services would have cost in an arms-length 
transaction.<SUP>48 This approach would require advisers to report 
positive values for unsolicited and unused services, which could lead 
investors to believe that the adviser (or the client) substantially 
benefited from the direction of the brokerage when, in fact, receipt of 
the services was incidental to brokerage direction decisions made 
wholly on the basis of the broker's execution capabilities. In 
addition, good faith estimates may be very difficult to make if the 
services provided are unlike those available for hard dollars. In this 
regard, the Commission is concerned with the burden that a good faith 
estimate requirement would impose on advisers and brokers and the 
accuracy of the information that would be reported to clients.<SUP>49

    \48\This approach was suggested by one commenter on the 
Commission's recent proposal to require that mutual fund expenses 
paid by brokers should be included in fund expense and performance 
data. See Investors Research Letter, supra note 25. In that 
proposal, the Commission requested comment whether the value of 
research services received by a fund's adviser should also be 
included in fund expenses, and how the research should be valued. 
See Investment Company Act Rel. No. 20472 (Aug. 11, 1994) (59 FR 
42187 (Aug. 17, 1994)), at Sec. II.A.1. Most commenters on the 
proposal, however, opposed the inclusion of research services in 
fund expenses, and those commenters that favored it generally 
provided little guidance regarding how to value proprietary 
services.
    \49\In proposing rule 28e2-1, the Commission proposed that the 
fair value of non-research services be disclosed, and requested 
comment on the feasibility and desirability of requiring disclosure 
of specific dollar amounts of brokerage commissions paid to receive 
research services. Commenters asserted that it would be 
impracticable to value soft dollar services or to separate 
commissions into their research and execution components. See 
Release 10569, supra note 41.
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    The disclosure that the Commission is proposing to require is 
designed to alert a client that the adviser receives soft dollar 
services from directing client commissions, and provide some indication 
of the extent to which the client benefits from that direction. The 
commission rate information, including the commission rates of 
execution-only brokers, may provide valuable information on the costs 
of soft dollar arrangements and may render valuation estimates 
unnecessary. If additional information is desired, the client can 
request it from the adviser.
    Comment is requested whether the commission price and fair market 
value of particular soft dollar services, or the soft dollar services 
obtained from a broker in the aggregate, should be required in the 
annual report. Commenters favoring inclusion of this information should 
discuss how the price and value of proprietary soft dollar services 
should be determined.

D. Client-Directed Brokerage

    Many clients of investment advisers instruct their advisers to 
direct some or all of their transactions to a particular broker or 
brokers. A client may direct its brokerage, among other reasons, to 
obtain services for its own benefit or because of a pre-existing 
relationship with the broker.
    In addition to disclosing the percentages of an adviser's total 
commissions that are directed to execution-only and research brokers, 
the proposed annual report would be required to disclose the percentage 
of commissions that is directed by clients.<SUP>50 Client restrictions 
on an adviser's brokerage discretion may be of interest to other 
clients of the adviser because they may cause a larger proportion of 
the brokerage of the other clients to be used to obtain soft dollar 
services for the adviser. Information on client-directed brokerage, 
therefore, may be useful to clients in determining the amount of 
brokerage available to the adviser to purchase soft dollar services. 
Comment is requested whether the proposed disclosure of the percentage 
of client-directed brokerage would be useful, and whether the 
Commission should require that the data be accompanied by disclosure 
explaining its usefulness.

    \50\Item 4 of proposed Form ADV-B.
E. Principal Transactions

    Proposed Form ADV-B would require an adviser to include in the 
commission and commission rate in the table mark-ups and mark-downs 
paid in connection with principal transactions if the amounts of these 
mark-ups or mark-downs are included in the confirmations of the 
transactions required under rule 10b-10 under the 1934 Act. Rule 10b-10 
requires that a dealer include transaction cost data in confirmations 
of (1) riskless principal transactions in equity securities if the 
dealer is not a market maker in the securities, and (2) transactions in 
a listed equity securities and certain Nasdaq securities.<SUP>51

    \51\Paragraph (a)(8) of rule 10b-10 [17 CFR 10b-10(a)(8)].
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    Proposed Form ADV-B would not require disclosure of information 
about other principal transactions or the mark-ups, mark-downs or 
spreads paid on these transactions. It may be difficult to accurately 
determine transaction costs associated with these principal 
transactions. Furthermore, disclosure about adviser direction of 
principal transactions may not be necessary, as soft dollar 
arrangements involving principal transactions may be less common than 
those involving agency transactions because principal transactions are 
not afforded the safe harbor provided by Section 28(e).<SUP>52

    \52\The safe harbor does not encompass soft dollar arrangements 
under which research services are acquired as a result of principal 
transactions. See note 10 supra. Notwithstanding the lack of 
availability of the safe harbor, the Commission understands that 
full service brokers sometimes provide research and other services 
based, at least in part, on principal transactions. If an adviser 
were required to list a broker in its annual report because the 
broker is used frequently for agency transactions, the adviser would 
be required to take all of the soft dollar services obtained from 
the broker into account in responding to the report's requirement to 
list the services obtained, even if some of the services could be 
deemed to be received as a result of principal transactions not 
within the scope of the proposed amendments. Instruction 7 to Item 2 
of proposed Form ADV-B.
---------------------------------------------------------------------------

    Comment is requested whether the annual report should include 
information on all principal transactions, and, if so, how the 
associated costs should be determined. Comment is also requested 
whether disclosure requirements that apply primarily to agency 
transactions would cause more transactions to be executed on a 
principal basis.
    The proposal would require disclosure of the brokers to which the 
greatest amounts of commissions had been directed. Alternatively, the 
obligation to disclose information about a broker could be based on the 
dollar amount of transactions, both principal and agency, directed to 
the broker. The resulting disclosure might be more useful to clients in 
assessing any relationship that may exist between the adviser's use of 
principal transactions and its receipt of soft dollar services. Comment 
is requested whether the basis for requiring a broker to be listed in 
the annual report should be the dollar amount of transactions directed 
to the broker, rather than the amount of commissions.

F. Client-Specific Information

    The proposed amendments would not require that an adviser provide 
each client with information about how that [[Page 9756]] client's 
brokerage was directed (``client-specific information''). Client-
specific information could assist a client in comparing the use of its 
brokerage with that of the adviser's other clients.<SUP>53 The benefits 
of a requirement to disclose client-specific information, however, may 
be outweighed by the time and cost to advisers of preparing separate 
reports for every client. This cost would likely be passed on to 
advisory clients. Furthermore, advisory clients currently receive or 
have access to confirmations of their transactions that disclose the 
identities of the brokers used and the amounts of commissions 
charged.<SUP>54 Comment is requested whether client-specific 
information should be required in the annual report and, if so, what 
information should be required.<SUP>55

    \53\To the extent differences between the manner in which an 
adviser uses a particular client's brokerage and the brokerage of 
the adviser's other clients is caused by client-directed brokerage, 
the requirement of the proposal to disclose the percentage of 
client-directed brokerage might render client-specific information 
unnecessary. See Section II.D supra.
    \54\See rule 10b-10 under the 1934 Act [17 CFR 240.10b-10] 
(requiring broker-dealers to send immediate confirmations of 
transactions to their customers). The confirmations, or quarterly 
statements containing all of the information required in the 
confirmations, must be sent to the holder of the account, rather 
than any fiduciary managing the account. See Securities Exchange Act 
Rel. No. 34962 (Nov. 10, 1994) [59 FR 59612 (Nov. 17, 1994)] at 
Sec. II.A.2.
    \55\As noted above, an adviser to an investment company is 
required to provide information about its soft dollar arrangements 
to the company's board of directors. See note 24 supra. The 
information provided by the adviser generally should include 
specific information about the adviser's use of the investment 
company's brokerage. The proposed annual report would supplement 
this fund-specific information.
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G. Delivery and Filing

    Reports on Form ADV-B would be prepared on an annual basis and 
would report on brokerage directed during the adviser's most recently 
completed fiscal year.<SUP>56 The report would be required to be filed 
with the Commission and delivered to clients no later than sixty days 
after the end of the fiscal year, and delivered to prospective clients 
no later than the time that an advisory contract is entered 
into.<SUP>57

    \56\Paragraph (a) of proposed rule 204-4; General Instructions 1 
and 5 to proposed Form ADV-B. The table in the annual report would 
be required to disclose commissions paid during the adviser's most 
recently completed fiscal year even if soft dollar services paid for 
with those commissions had been or will be received during another 
fiscal year. Conversely, disclosure of soft dollar services received 
during a fiscal year would be required even if commissions were or 
will be directed to pay for those services during another fiscal 
year. General Instruction 5 to proposed Form ADV-B.
    \57\Paragraphs (a) and (b) of proposed rule 204-4; General 
Instructions 3 and 4 to proposed Form ADV-B. Rule 204-3 under the 
Advisers Act, which generally requires advisers to furnish a 
disclosure brochure to prospective clients no later than 48 hours 
prior to the time that the advisory contract is entered into, 
permits the brochure to be delivered at the time that the contract 
is entered into if the contract can be terminated without penalty 
within five business days. Paragraph (b)(1) of rule 204-3 [17 CFR 
275.204-3(b)(1)]. Proposed rule 204-4 would not similarly 
differentiate between providing the annual report before or at the 
time that the contract is entered into. Generally, however, the 
determination of when a contract is entered into would be the same 
for the purposes of both rules.
---------------------------------------------------------------------------

    Because the report would provide information about brokerage over 
which the adviser has discretion, the report would be required to be 
delivered only to those clients over whose accounts the adviser has or 
will have brokerage discretion. An adviser would be considered to have 
brokerage discretion over an account if it (1) had the authority to 
determine, without obtaining specific client consent, the brokers to be 
used or the commissions paid in connection with any transactions for 
the account, or (2) significantly influenced the selection of brokers 
by a client and received soft dollar services from a broker chosen by 
the client.<SUP>58 An adviser would not be required to provide the 
report to a client that, without the adviser's influence, directed that 
a single broker execute its transactions, or prior to each transaction 
approved the broker to be used for the transaction.<SUP>59 Comment is 
requested whether this definition of brokerage discretion is 
appropriate, and whether the report should be required to be delivered 
to clients over whose accounts the adviser does not have brokerage 
discretion.

    \58\Paragraph (c)(1) of proposed rule 204-4; General Instruction 
2 to proposed Form ADV-B. An adviser would not be deemed to have 
brokerage discretion over an account if substantially all of the 
client's transactions were directed to a broker that was compensated 
for executing the transactions based upon a percentage of the assets 
managed by the adviser, such as in a ``wrap fee'' program, even if 
the adviser could in certain circumstances direct the client's 
transactions to other brokers.
    \59\An adviser would be required to deliver the annual report to 
a client if the adviser had discretion over any of the client's 
brokerage, even if some or most of the client's brokerage was 
directed by the client. Delivery of the annual report also would be 
required if the adviser had the authority to select brokers for 
particular transactions from a list previously approved by the 
client.
---------------------------------------------------------------------------

    The Commission is proposing that the report be prepared on an 
annual basis. More frequent reporting would be more costly and may not 
be necessary for clients to monitor an adviser's brokerage direction 
practices. Furthermore, an annual report may provide a more 
representative sample of an adviser's brokerage practices. Comment is 
requested whether the report should be required to be prepared more 
frequently than annually, such as quarterly.<SUP>60

    \60\The Morgan/Goldman Proposal would have required quarterly 
reporting.
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H. Goldman/Morgan Proposal

    The Goldman/Morgan Proposal differs from the Commission's proposal 
in a number of respects. The Goldman/Morgan Proposal would, among other 
things, require quarterly rather than annual reporting, require 
disclosure of the commission price and value of specific third-party 
soft dollar services, and require disclosure of certain client-specific 
information. The Commission has requested comment on these elements of 
the Goldman/Morgan Proposal separately in this Release. The Commission 
also requests comment whether the Goldman/Morgan Proposal generally 
would be preferable to the Commission's proposal.

III. Disclosure By Brokers Providing Soft Dollar Services

    The amendments being proposed in this Release would require 
disclosure by advisers that receive soft dollar services from brokers. 
In a letter to the staff, Autranet, Inc. (``Autranet''), a broker 
providing third-party soft dollar services to advisers, proposed an 
entirely different approach that would impose certain recordkeeping and 
disclosure requirements on brokers providing third-party soft dollar 
services to ensure that the services were provided within the safe 
harbor of Section 28(e) of the Exchange Act.<SUP>61 Under the Autranet 
[[Page 9757]] proposal, these brokers would be required to demonstrate 
that they incurred a legal obligation to provide soft dollar services 
to an adviser. This obligation could be demonstrated either by a 
contract that indicates the broker's financial obligation to purchase 
the soft dollar services from an independent research originator, or by 
an invoice showing the broker's payment for the services for those soft 
dollar services not typically the subject of a contract.

    \61\Autranet also has proposed that the Commission prohibit 
understandings that commit an adviser to a predetermined amount of 
commissions in exchange for soft dollar services. The Commission 
requests comment on the feasibility of this proposal. In particular, 
the Commission requests comment whether prohibiting a stated 
commission ratio in exchange for soft dollar services will deter the 
negotiation of commission rates and cause advisers that are less 
sophisticated or influential to pay higher commissions.
    In addition, Autranet proposed that the Commission ensure that 
an independent research originator make its services available to a 
number of brokers and not enter into exclusive agreements. For 
instance, under ``bump up'' or bonus arrangements a vendor will 
assign a cash value to its product and offer it to the public at 
large for a lower price than charged to a broker providing the 
product pursuant to a soft dollar arrangement. In other 
arrangements, a vendor will tie the availability of its product to a 
single affiliated or unaffiliated broker, thus causing all trades to 
go through that broker in exchange for the service. Autranet 
believes that by eliminating commission commitments and exclusivity 
arrangements, a client can be better assured that the adviser 
obtained the best execution of the client's order. The Commission 
requests comment on the feasibility of a prohibition on exclusivity 
and bonus arrangements and whether such a proposal would accomplish 
the objective of assuring best execution. The Commission also has 
forwarded these proposals to the NASD for its consideration under 
its authority to promulgate just and equitable principles of trade.
---------------------------------------------------------------------------

    In addition, Autranet proposes that third-party soft dollar brokers 
be required to provide a description of the soft dollar services 
provided in an arrangement and specify how the product assists an 
adviser in its investment decisions. A broker would be required to make 
this description available to the managed account upon request and 
provide the managed account a quarterly report showing the cost of the 
soft dollar service. For products having a mixed-use, Autranet proposes 
that the broker providing such a product obtain from the adviser a 
description of the adviser's use of the product and the adviser's 
allocation between the research and non-research functions of the 
product.
    Autranet proposes that these descriptions be reflected in an annual 
report that third-party soft dollar brokers would file with the 
Commission and provide to the advisers receiving soft dollar services 
and to the clients of those advisers whose commissions were used to 
obtain the soft dollar services. Autranet proposes that the report 
include (1) a disclosure statement describing the business of the third 
party broker; (2) a financial summary, quantifying on an aggregate 
basis the value by category and, if necessary, sub-category, of the 
soft dollar services provided; (3) a compliance report, demonstrating 
that the soft dollar services were in compliance with the requirements 
set forth above and within the safe harbor of Section 28(e); and (4) an 
independent auditor's report. Autranet believes that such a reporting 
requirement would not be costly to third-party brokers because the 
information required is readily available and the reporting 
requirements should reflect compliance procedures already established 
by third-party brokers providing soft dollar services.
    The Commission requests comment on whether some or all of the 
Autranet proposals would be practical additions to the disclosure 
currently required and proposed of advisers. In particular, the 
Commission requests comment on the costs associated with this 
disclosure approach and the ease with which this information could be 
obtained by brokers and provided to advisers and their clients. In 
addition, the Commission requests comment on the extent to which full 
service brokers providing proprietary soft dollar services could or 
should be subject to any of the reporting requirements proposed by 
Autranet.

IV. General Request For Comments

    Any interested persons wishing to submit written comments on the 
proposals that are the subject of this Release, to suggest additional 
changes, or to submit comments on other matters that might have an 
effect on the proposals that are contained in this Release, are 
requested to do so.

V. Cost/Benefit Analysis

    The rule and form proposed today are intended to provide material 
information to clients and prospective clients of investment advisers 
that can be used to evaluate an adviser's brokerage direction and soft 
dollar practices. The proposals would enable an advisory client to 
better assess whether its adviser is directing its brokerage in 
accordance with its best interests, and whether the advisory fee it 
pays is appropriate in light of the services provided and costs 
incurred directly by the adviser.
    Adoption of the proposal would impose some additional costs on 
advisers required to prepare the report and deliver it to clients. The 
Commission believes, however, that the proposals appropriately balance 
the need for additional disclosure with the costs of providing that 
disclosure. The information that would be required by the proposal 
should readily be determinable by an adviser. A number of alternatives 
that would make the disclosure requirements more burdensome, such as 
requiring advisers to disclose the value of soft dollar services 
received or report on the use of each client's brokerage, are not being 
proposed. Furthermore, because the report would need to be prepared and 
delivered only annually, the costs of preparing and delivering the 
report should be minimized. In short, the Commission believes that the 
costs of the proposals would be outweighed by the benefits to advisory 
clients in receiving more useful information about their advisers' 
direction of client brokerage.

VI. Summary Of Initial Regulatory Flexibility Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis in accordance with 5 U.S.C. 603 regarding the proposed 
amendments. The analysis notes that the rule and form proposed in this 
Release are intended to provide investment advisory clients for whom 
the adviser selects brokers to execute client transactions with 
information about the services the adviser receives from those brokers 
and the commissions charged by those brokers. Other aggregate cost-
benefit information reflected in the ``Cost/Benefit Analysis'' section 
of this Release also is reflected in the analysis. A copy of the 
Initial Regulatory Flexibility Analysis may be obtained by contacting 
Jana M. Cayne, Securities and Exchange Commission, 450 Fifth Street, 
NW., Mail Stop 10-6, Washington, DC 20549.

VII. Statutory Authority

    The Commission is proposing rule 204-4 and Form ADV-B under the 
authority set forth in Sections 204, 206(4) and 211(a) of the Advisers 
Act [15 U.S.C. 80b-4, 80b-6(4) and 80b-11(a)] and Section 28(e)(2) of 
the 1934 Act [15 U.S.C. 78bb(e)(2)].

Text Of Proposed Rule And Form Amendments

List of Subjects in 17 CFR Parts 275 and 279

    Investment advisers, Reporting and recordkeeping requirements.

    For the reasons set out in the preamble, title 17, chapter II of 
the Code of Federal Regulations is proposed to be amended as follows.

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

    1. The authority citation for Part 275 is amended by adding the 
following citation:

    Authority: 15 U.S.C. 80b-3, 80b-4, 80b-6A, 80b-11, unless 
otherwise noted.
* * * * *
    Section 275.204-4 is also issued under 15 U.S.C. 78bb(e)(2).
    2. By adding Sec. 275.204-4 to read as follows:


Sec. 275.204-4  Annual report on brokerage practices.

    (a) Each investment adviser, registered or required to be 
registered under Section 203 of the Act on the last day of its most 
recently completed fiscal year, that exercised brokerage discretion 
over the account of any client during that fiscal year and obtained 
services other than execution services from a broker to which it 
directed client brokerage during that fiscal year shall file a report 
on Form ADV-B with the Commission no later than 60 days after the end 
of that fiscal year, unless the investment adviser's registration was 
[[Page 9758]] withdrawn, cancelled or revoked after the end of the 
fiscal year.
    (b) An investment adviser required to file a report on Form ADV-B 
pursuant to paragraph (a) of this section shall furnish such report for 
its most recently completed fiscal year:
    (1) No later than 60 days after the end of each fiscal year, to 
each advisory client over whose account the investment adviser 
exercises brokerage discretion; and
    (2) No later than the time that a written or oral investment 
advisory contract is entered into, to each new or prospective advisory 
client over whose account the investment adviser will or proposes to 
exercise brokerage discretion.
    (c) For purposes of this section:
    (1)(i) An investment adviser exercises ``brokerage discretion'' 
over a client's account if it:
    (A) Has authority to determine, without obtaining specific client 
consent, the broker to be used or the commission rates paid in 
connection with any transaction of the client; or
    (B) Significantly influences the selection of brokers by the client 
and receives services other than execution services from a broker 
chosen by the client.
    (ii) An investment adviser does not exercise brokerage discretion 
over a client's account if substantially all of the client's 
transactions were directed to a broker that was compensated for 
executing such transactions solely based upon a specified percentage of 
the assets managed by the investment adviser; and
    (2) Execution services mean those services set forth in paragraph 
(e)(3)(C) of Section 28 of the Securities Exchange Act of 1934 (15 
U.S.C. 78bb(e)(3)(C)).

PART 279--FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 
1940

    3. The authority citation for Part 279 is amended by adding the 
following citation:

    Authority: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1, 
et seq.

    Section 275.204-4 is also issued under 15 U.S.C. 78bb(e)(2).
    4. By adding Sec. 279.9 and Form ADV-B to read as follows:


Sec. 279.9  Form ADV-B, annual report on investment adviser's brokerage 
direction practices.

    This form shall be filed annually by an investment adviser, 
registered or required to be registered under the Investment Advisers 
Act of 1940, that has the authority to select brokers to execute the 
transactions of any client and that obtains services other than 
execution from a broker to which it directs client brokerage.

    Note: Form ADV-B is attached as Appendix 1 to this document. The 
Form will not appear in the Code of Federal Regulations.

    Dated: February 14, 1995.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
Appendix 1

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U.S. Securities and Exchange Commission, Washington, DC 20549

Form ADV-B

Annual Report on Brokerage Practices for Registered Investment Advisers 
Having Discretion Over Client Brokerage

Applicant:-------------------------------------------------------------

SEC File Number: 801---------------------------------------------------

Date:------------------------------------------------------------------

MM/DD/YY

General Instructions for Preparing and Filing Form ADV-B

    1. Applicability of Form Requirement. A report on Form ADV-B 
must be prepared and filed by every investment adviser that (i) was 
registered or required to be registered under the Investment 
Advisers Act of 1940 on the last day of its most recently completed 
fiscal year (unless the adviser's registration has since been 
withdrawn, cancelled or revoked), (ii) exercised ``brokerage 
discretion'' over the account of any advisory client during that 
fiscal year, and (iii) obtained services other than ``execution 
services'' from a broker to which it directed client brokerage 
during that fiscal year.
    2. Definitions.
    Brokerage Discretion. An investment adviser exercises brokerage 
discretion over a client's account if it (i) has the authority to 
determine, without obtaining specific client consent, the broker to 
be used or the commission rates paid in connection with any 
transaction of the client, or (ii) significantly influences the 
selection of brokers by the client and receives services other than 
execution services from a broker chosen by the client. An investment 
adviser does not have discretion over a client's account, however, 
if substantially all of the client's transactions were directed to a 
broker that was compensated for executing such transactions solely 
based upon a specified percentage of the assets managed by the 
adviser, even if the adviser has the discretion to direct certain of 
the client's transactions to other brokers.
    Execution Services. Execution services mean those services 
described in Section 28(e)(2)(C) of the Securities Exchange Act of 
1934, i.e., effecting securities transactions and performing 
functions incidental thereto or required in connection therewith by 
rules of the Securities and Exchange Commission or a self-regulatory 
organization.
    3. Format and Filing of Report. The report required by this form 
should be prepared as a separate document, not on copies of this 
Form. The report shall be filed in triplicate with the Securities 
and Exchange Commission, 450 Fifth Street NW., Washington, DC 20549. 
Each copy of the report filed with the Commission should be attached 
to a completed copy of this page, although only one such copy need 
be manually executed. The report shall be filed no later than 60 
days after the end of the adviser's fiscal year.
    Execution: The undersigned represents that he or she has 
executed this form on behalf of, and with the authority of, said 
investment adviser. The undersigned and the investment adviser 
represent that the information and statements contained herein, 
including exhibits attached hereto and other information filed 
herewith, all of which are made a part hereof, are current, true, 
and complete.

    Dated the ________ day of ____________________, 19______

----------------------------------------------------------------------
(Name of registrant)

By:--------------------------------------------------------------------
(Signature and title)

    4. Delivery.
    Existing Clients. Rule 204-4 under the Investment Advisers Act 
of 1940 requires that the report be furnished no later than 60 days 
after the end of the investment adviser's most recently completed 
fiscal year to each advisory client over whose account the adviser 
exercises brokerage discretion (as defined in Instruction 2 above).
    Prospective Clients. Rule 204-4 also requires that the report be 
furnished no later than the time that a written or oral investment 
advisory contract is entered into to each new or prospective 
advisory client over whose account the adviser will or proposes to 
exercise brokerage discretion.
    5. Period of Required Data. An investment adviser must provide 
the requested information for its most recently completed fiscal 
year. Brokerage commissions directed or services received during a 
fiscal year should be included in the table, even if the services 
corresponding to commissions directed during the fiscal year were or 
will be received during another fiscal year, or the commissions 
corresponding to services received during the fiscal year were or 
will be directed during another fiscal year.
    6. Additional Information. An investment adviser may, in 
addition to providing the required information, provide other 
information, including additional data and explanations of the 
required information, about its brokerage practices in its response 
to this Form.

Information Required in Annual Report

Item 1. General Description of Report

    In an introduction to the report:
    (a) explain that the report contains information about the 
adviser's practices in selecting brokers to execute transactions for 
its investment advisory clients that can be used to evaluate whether 
the adviser directs [[Page 9759]] client transactions consistent 
with the best interests of its clients;
    (b) explain that the information contained in the report is 
provided on a firm-wide basis, that the report does not include 
specific information about the brokerage of any particular client or 
the extent to which services obtained are used for the benefit of 
any particular client, and that clients should refer to the 
confirmations or quarterly account statements provided by their 
brokers or contact the adviser for information about the brokers 
used to execute their transactions;
    (c) explain, if applicable, that the report does not include 
information about many transactions executed on a ``principal'' 
basis, that, in principal transactions, transaction costs typically 
are included in the price of the securities purchased or sold and 
are not charged as separate commissions, and that transactions in 
certain types of securities typically are executed on a principal 
basis; and
    (d) provide an address or phone number at which a client can 
contact the adviser to request more information.

Item 2. Information Regarding the Twenty Most Frequently Used 
Brokers

    Using the captions and tabular format illustrated below, provide 
the required information for the twenty brokers (other than 
``execution-only'' brokers as defined in Item 3) to which the 
investment adviser directed the greatest amount of client 
commissions. If no or fewer than twenty such brokers were used, 
state either ``no brokers used that provided services other than 
execution'' after the title or ``no additional brokers used'' after 
the last broker listed.

                                                                                                                
              The Twenty Brokers to Which the Greatest Amounts of Client Commissions Were Directed              
                                                                                                                
----------------------------------------------------------------------------------------------------------------
                               Commissions paid to                                                              
         Aggregate amount of      broker (as a                               Description of                     
 Name       discretionary         percentage of      Average commission    services obtained                    
  of     commissions paid to        adviser's          rate (in cents/        (other than                       
broker   broker (in dollars)      discretionary            share)         execution services)                   
                                  commissions)                                                                  
---------------------------------------------------------------------------------------------                   
                                                                                                                

Instructions

    1. For the purposes of this Form, brokers include broker-dealers 
registered under the Securities Exchange Act of 1934, banks, and, as 
set forth in Item 3, automated trading systems.
    2. ``Discretionary commissions'' are those commissions, mark-ups 
and mark-downs that are disclosed on the transaction confirmations 
required under rule 10b-10 under the Securities Exchange Act of 1934 
and that are paid in connection with transactions for which the 
investment adviser had the authority to determine, without obtaining 
specific client consent, the broker or dealer to be used or the 
commission rates paid.
    3. Commissions include sales loads paid in connection with 
transactions in investment company shares, although sales loads 
should not be considered in calculating the average commission rate. 
If the adviser directed transactions in investment company shares to 
a broker other than the principal underwriter of the investment 
company, that broker, rather than the principal underwriter, should 
be considered to have executed the transaction.
    4. For purposes of this Form, commissions do not include fees 
for brokerage services that are based upon a specified percentage of 
the assets managed (i.e., fees paid under ``wrap fee'' programs).
    5. Calculate average commission rates on a ``share-weighted'' 
basis (i.e., by dividing the total amount of client commissions that 
the investment adviser directed to the broker by the total number of 
shares, exclusive of investment company shares, purchased or sold by 
the broker for the adviser's clients).
    6. For the purposes of determining commission amounts and 
average commission rates, convert any commission charged in foreign 
currency to dollars (and cents per share). The investment adviser 
may use any reasonable means and times for determining the 
applicable exchange rate as long as those means and times are used 
on a consistent basis.
    7. Under ``Description of Services Obtained,'' products or 
services obtained by the investment adviser from each broker, 
including computer hardware, software, databases, and on-line 
services, publications available by subscription, and services 
falling outside the scope of Section 28(e) of the Securities 
Exchange Act of 1934, generally should be identified separately and 
specifically. Research reports and contacts with securities analysts 
or professionals, however, may be described generally by the 
following terms: (i) analyses and reports on specific securities, 
issuers, or industries, (ii) general political or economic analyses 
or reports, or (iii) contacts with securities analysts. The party 
that produced a specifically identified product or service should 
also be identified unless the producer's name is evident from the 
name of the product or service. An adviser should report all 
products or services received from a broker, even if some of the 
services could be deemed to have been received as a result of 
principal transactions the costs of which are not required to be 
reported in the table.

Item 3. Information Regarding Three Most Frequently Used Execution-
Only Brokers

    Using the captions specified under Item 2 (except ``Description 
of Services Obtained''), provide a table titled ``The Three 
Execution-only Brokers to which the Greatest Amounts of Client 
Commissions were Directed'' that includes the required information 
for the three execution-only brokers to which the investment adviser 
directed the greatest amount of client commissions. If no or fewer 
than three execution-only brokers were used, state either ``no 
execution-only brokers used'' after the title or ``no additional 
execution-only brokers used'' after the last broker listed.

Instruction

    For the purposes of this Item, a broker should be considered an 
execution-only broker if substantially all of the services that it 
provides to the adviser are execution services (see the definition 
in Instruction 2 of the General Instructions). An automated trading 
system should be considered an execution-only broker if 
substantially all of the services received by the adviser in 
connection with using the system are execution services and if a fee 
is charged for using the system, regardless of the basis for the fee 
(e.g., a flat usage fee or transaction-based charges).

Item 4. Information Regarding Brokerage Business Directed by 
Clients

    Provide the following information under the following captions:
    Percentage of Total Commissions Directed to Brokers Providing 
Research and Other Services in Addition to Execution:
    Percentage of Total Commissions Directed to Execution-only 
Brokers:
    Percentage of Total Commissions Directed by Clients:

Instruction

    For the purposes of this Item, commissions directed by clients 
are those commissions paid by accounts managed by the adviser that 
were directed pursuant to client requests or instructions. Total 
commissions equal the sum of the adviser's discretionary 
commissions, as defined in Item 2, and the commissions directed by 
clients.

[FR Doc. 95-4160 Filed 2-17-95; 8:45 am]
BILLING CODE 8010-01-P