45646 Federal Register / Vol. 73, No. 152 / Wednesday, August 6, 2008 / Proposed Rules 

1Enhanced Disclosure and New Prospectus 

Delivery Option for Registered Open-End 

Management Investment Companies, Securities Act 

Release No. 8861 (Nov. 21, 2007) [72 FR 67790 

(Nov. 30, 2007)]. 

Issued in Fort Worth, Texas, on July 27, 

2008. 

Mark R. Schilling, 

Acting Manager, Rotorcraft Directorate, 

Aircraft Certification Service. 

[FR Doc. E8–17992 Filed 8–5–08; 8:45 am] 

BILLING CODE 4910–13–P 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Parts 230, 232, 239, and 274 

[Release Nos. 33–8949; IC–28346; File No. 

S7–28–07] 

RIN 3235–AJ44 

Enhanced Disclosure and New 

Prospectus Delivery Option for 

Registered Open-End Management 

Investment Companies 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule; reopening of 

comment period. 

SUMMARY: The Securities and Exchange 

Commission is reopening the period for 

public comment on amendments it 

originally proposed in Securities Act 

Release No. 8861 (Nov. 21, 2007) [72 FR 

67790 (Nov. 30, 2007)]. The rule 

proposal would, if adopted, require key 

information to appear in plain English 

in a standardized order at the front of 

the mutual fund prospectus; and permit 

a person to satisfy its mutual fund 

prospectus delivery obligations under 

section 5(b)(2) of the Securities Act of 

1933 by sending or giving the key 

information directly to investors in the 

form of a summary prospectus and 

providing the statutory prospectus on an 

Internet Web site. 

DATES: Comments should be received on 

or before August 29, 2008. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/proposed.shtml); 

• Send an e-mail to rulecomments@sec.gov. Please include File 

No. S7–28–07 on the subject line; or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Florence E. Harmon, Acting 

Secretary, Securities and Exchange 

Commission, 100 F Street, NE., 

Washington, DC 20549–1090. 

All submissions should refer to File No. 

S7–28–07. This file number should be 

included on the subject line if e-mail is 

used. To help us process and review 

your comments more efficiently, please 

use only one method. The Commission 

will post all comments on the 

Commission’s Internet Web site (http:// 

www.sec.gov). Comments are also 

available for public inspection and 

copying in the Commission’s Public 

Reference Room, 100 F Street, NE., 

Washington, DC 20549, on official 

business days between the hours of 10 

a.m. and 3 p.m. All comments received 

will be posted without change; we do 

not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly. 

FOR FURTHER INFORMATION CONTACT: 

Deborah D. Skeens, Senior Counsel, 

Office of Disclosure Regulation, 

Division of Investment Management, at 

(202) 551–6784, Securities and 

Exchange Commission, 100 F Street, 

NE., Washington, DC 20549–5720. 

SUPPLEMENTARY INFORMATION: The 

Securities and Exchange Commission 

(‘‘Commission’’) is reopening the period 

for public comment on proposed rule 

and form amendments that are intended 

to enhance the disclosures that are 

provided to mutual fund investors. 

These amendments were proposed on 

November 21, 2007,1 and the comment 

period initially closed on February 28, 

2008. The Commission’s proposal 

would, if adopted, require key 

information to appear in plain English 

in a standardized order at the front of 

the mutual fund statutory prospectus. 

The proposals also would permit a 

person to satisfy its mutual fund 

prospectus delivery obligations under 

Section 5(b)(2) of the Securities Act of 

1933 by sending or giving the key 

information directly to investors in the 

form of a summary prospectus and 

providing the statutory prospectus on an 

Internet Web site. Upon an investor’s 

request, mutual funds would also be 

required to send the statutory 

prospectus to the investor. 

The Commission recently engaged a 

consultant to conduct focus group 

interviews and a telephone survey 

concerning investors’ views and 

opinions about various disclosure 

documents filed by companies, 

including mutual funds. During this 

process, investors participating in focus 

groups were asked questions about, 

among other things, a hypothetical 

summary prospectus. Investors 

participating in the telephone survey 

were asked questions relating to several 

disclosure documents, including mutual 

fund prospectuses. We have placed in 

the comment file (available at http:// 

www.sec.gov) for the proposed rule the 

following documents from the investor 

testing that relate to mutual fund 

prospectuses and the proposed 

summary prospectus: (1) The 

consultant’s report concerning focus 

group testing of the hypothetical 

summary prospectus and related 

disclosures; (2) transcripts of focus 

groups relating to the hypothetical 

summary prospectus and related 

disclosures; (3) disclosure examples 

used in these focus groups; and (4) an 

excerpt from the consultant’s report 

concerning the telephone survey of 

individual investors. In order to provide 

all persons who are interested in this 

matter an opportunity to comment on 

these additional materials, we believe 

that it is appropriate to reopen the 

comment period before we take action 

on the proposal. 

We invite additional comment on the 

proposal in light of these materials, and 

on any other matters that may have an 

effect on the proposal. 

Accordingly, we will extend the 

comment period until August 29, 2008. 

By the Commission. 

Dated: July 31, 2008. 

Florence E. Harmon, 

Acting Secretary. 

[FR Doc. E8–18036 Filed 8–5–08; 8:45 am] 

BILLING CODE 8010–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 275 

[Release Nos. 34–58264; IC–28345; IA–2763 

File No. S7–22–08] 

RIN 3235–AJ45 

Commission Guidance Regarding the 

Duties and Responsibilities of 

Investment Company Boards of 

Directors With Respect to Investment 

Adviser Portfolio Trading Practices 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed guidance; request for 

comment. 

SUMMARY: The Securities and Exchange 

Commission is publishing for comment 

this proposed guidance to boards of 

directors of registered investment 

companies to assist them in fulfilling 

their fiduciary responsibilities with 


yshivers on PROD1PC62 with PROPOSALS
Federal Register / Vol. 73, No. 152 / Wednesday, August 6, 2008 / Proposed Rules 45647 

1 15 U.S.C. 78bb(e). For a discussion of the 

section 28(e) safe harbor, see infra section III.C. 

Whereas section 28(e) refers to a money manager as 

a ‘‘person * * * [who] exercise[s] * * * investment 

discretion with respect to an account,’’ we refer to 

money managers to funds in this Release as 

‘‘investment advisers.’’

2 15 U.S.C. 78a. 

3Commission Guidance Regarding Client 

Commission Practices Under section 28(e) of the 

Securities Exchange Act of 1934, Exchange Act 

Release No. 54165 (July 18, 2006) [71 FR 41978 

(July 24, 2006)] (‘‘2006 Release’’). 

4See infra section III (discussing fund directors’

obligations with respect to overseeing advisers’

trading of fund portfolio securities). Broadly 

defined, a fund’s transaction costs include all of its 

costs that are associated with trading portfolio 

securities. Transaction costs may include, among 

other things, commissions, spreads, market impact 

costs, and opportunity costs. Concept Release: 

Request for Comments on Measures to Improve 

Disclosure of Mutual Fund Transaction Costs, 

Investment Company Act Release No. 26313 (Dec. 

18, 2003) [68 FR 74820 (Dec. 24, 2003)] (‘‘Concept 

Release’’), at section II.A. For purposes of this 

Release, the use of the term ‘‘securities’’ includes 

all instruments that an investment company may 

invest in under the Investment Company Act of 

1940 [15 U.S.C. 80a] (‘‘Investment Company Act’’). 

5See Concept Release at section I. However, we 

are aware that the interests of a fund’s adviser and 

the fund’s investors generally are aligned when an 

adviser places fund trades because advisers 

typically seek to minimize transaction costs due to 

the fact that such costs may detract from the fund’s 

performance. 

6For example, one study estimates that the 

average annual trading cost for a sample of 1706 

U.S. equity funds during the period 1995–2005 was 

almost 20 percent higher than the average expense 

ratio for those funds. These estimates include the 

effect of commissions, spreads, and market impact 

costs. Roger M. Edelen, Richard Evans & Gregory 

Kadlec, Scale Effects in Mutual Fund Performance: 

The Role of Trading Costs (working paper dated 

March 17, 2007), available at http:// 

papers.ssrn.com/sol3/ 

papers.cfm?abstract_id=951367. 

7See Concept Release at section I. 

8See id. See also infra section II at note 26 and 

accompanying text (discussing the external 

management structure of most funds). 

9See Role of Independent Directors of Investment 

Companies, Investment Company Act Release No. 

24082 (Oct. 14, 1999) [64 FR 59826 (Nov. 3, 1999)], 

at nn.7 & 12 (‘‘Mutual funds are formed as 

corporations or business trusts under state law and, 

like other corporations and trusts, must be operated 

for the benefit of their shareholders. * * * Under 

state law, directors are generally responsible for the 

Continued 

respect to overseeing the trading of 

investment company portfolio 

securities. The guidance focuses on the 

role of an investment company board in 

overseeing the best execution 

obligations of the investment adviser 

hired to invest in securities and other 

instruments on the investment 

company’s behalf. In this respect, we 

address the conflicts of interest that may 

exist when an investment adviser uses 

an investment company’s brokerage 

commissions to purchase services other 

than execution, such as the purchase of 

brokerage and research services through 

client commission arrangements. The 

Commission also is requesting comment 

on whether to propose that advisers be 

subject to new disclosure requirements 

concerning the use of client commission 

arrangements to investment company 

shareholders and other investment 

advisory clients. 

DATES: Comments should be received on 

or before October 1, 2008. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/proposed.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–22–08 on the subject line; 

or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Please 

follow the instructions provided for 

submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Secretary, Securities and Exchange 

Commission, 100 F Street, NE., 

Washington, DC 20549–1090. 

All submissions should refer to File 

Number S7–22–08. This file number 

should be included on the subject line 

if e-mail is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/ 

proposed.shtml). Comments are also 

available for public inspection and 

copying in the Commission’s Public 

Reference Room, 100 F Street, NE., 

Washington, DC 20549 on official 

business days between the hours of 10 

a.m. and 3 p.m. All comments received 

will be posted without change; we do 

not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly. 

FOR FURTHER INFORMATION CONTACT: 

Matthew N. Goldin, Senior Counsel, 

Karen L. Rossotto, Advisor to the 

Director, or Thomas R. Smith, Jr., Senior 

Advisor to the Director, Office of the 

Director, at 202–551–6720, Division of 

Investment Management, Securities and 

Exchange Commission, 100 F Street, 

NE., Washington, DC 20549–0506. 

I. Introduction and Summary 

Many investment advisers, in 

connection with trades placed on behalf 

of their registered investment company, 

or ‘‘fund,’’ clients, receive brokerage and 

research services in reliance on the safe 

harbor provided under section 28(e) 1 of 

the Securities Exchange Act of 1934 

(‘‘Exchange Act’’).2 In recent years, 

changes in client commission practices, 

evolving technologies, and marketplace 

developments have transformed the 

brokerage and investment management 

industries and securities trading 

practices. In recognition of changing 

market conditions and current industry 

practices, in July 2006, we issued an 

interpretive release that provided 

guidance to investment advisers with 

respect to, among other things, the 

scope of the safe harbor provided under 

section 28(e) when advisers use 

brokerage commissions to purchase 

brokerage and research services for their 

managed accounts.3 In addition to 

providing guidance to investment 

advisers on their use of soft dollars, we 

believe it is important to provide 

guidance to fund boards of directors 

concerning their responsibilities to 

oversee the adviser’s satisfaction of its 

best execution obligations, including the 

adviser’s use of fund brokerage 

commissions and the overall transaction 

costs that the fund incurs when the fund 

buys or sells portfolio securities.4 As we 

have stated previously, transaction costs 

are a concern for fund investors for two 

reasons.5 First, for many funds, the 

amount of transaction costs incurred 

may be substantial.6 Second, fund 

advisers are subject to a number of 

potential conflicts of interest in 

conducting portfolio transactions on 

behalf of clients that are funds.7 Fund 

brokerage commissions, which are paid 

out of fund assets, may, for example, be 

used to obtain brokerage and research 

services under section 28(e) of the 

Exchange Act that might otherwise be 

paid for directly by the fund’s 

investment adviser. 

We recognize that conflicts of interest 

are inherent when an investment 

adviser manages money on behalf of 

multiple clients. As discussed in section 

II of this Release, conflicts are also 

inherent in the external management 

structure of funds. Investment advisers 

are required to disclose material 

conflicts of interest to their clients, and 

those conflicts should be managed 

appropriately. Fund directors play a 

pivotal role in overseeing conflicts of 

interest investment advisers face when 

they have funds as clients. As explained 

in further detail in section III of this 

Release, fund transaction costs may not 

be readily apparent to investors. It is 

imperative that the fund’s directors both 

understand and scrutinize the payment 

of transaction costs by the fund 8 and 

determine that payment of transaction 

costs is in the best interests of the fund 

and the fund’s shareholders.9 Although 


yshivers on PROD1PC62 with PROPOSALS
45648 Federal Register / Vol. 73, No. 152 / Wednesday, August 6, 2008 / Proposed Rules 

oversight of all of the operations of a mutual 

fund.’’). 

10The directors of an investment company have 

a continuing fiduciary duty to oversee the 

company’s brokerage practices. See 2006 Release at 

n.6 (citing Order Approving Proposed Rule Change 

and Related Interpretation under section 36 of the 

Investment Company Act, Investment Company Act 

Release No. 11662 (Mar. 4, 1981) [46 FR 16012 

(Mar. 10, 1981)]). See also 2 Tamar Frankel, 

Regulation of Money Managers 67 (1978) (‘‘The 

directors should examine the adviser’s practices in 

placing portfolio transactions with broker dealers 

and the use of the brokerage business for the benefit 

of the adviser or its affiliates, and ensure that there 

are no violations [ ] of the law. * * *’’) (citing Lutz 

v. Boas, 39 Del. Ch. 585, 171 A.2d 381 (1961) and 

William J. Nutt, A Study of Mutual Fund 

Independent Directors, 120 U. Pa. L. Rev. 179, 181 

(1971)). 

11See Concept Release at section I. 

12 In connection with these requests for guidance, 

fund directors have informed us that fund boards 

are spending increasing amounts of time on trading 

practices in light of the growing complexity in this 

area. 

13At the July 12, 2006 open meeting at which the 

Commission considered the 2006 Release, several of 

the Commissioners specifically noted that guidance 

for fund boards was a critical element in protecting 

investors against abuses in this area. An electronic 

link to an archived webcast of the open meeting is 

available at http://www.connectlive.com/events/ 

secopenmeetings. 

14See infra section III. See also 2006 Release at 

section II.A. 

15 In light of the advancements in the market and 

the continuously evolving technology influencing 

industry practices, the Commission staff talked with 

a variety of investment advisers and industry 

representatives, including independent fund 

directors and directors’ counsel, to help ensure that 

our proposed guidance today reflects actual market 

practices and is based on factual industry 

experience. 

16See, e.g., A. Joseph Warburton, Should Mutual 

Funds Be Corporations: A Legal & Econometric 

Analysis, 33 Iowa J. Corp. L. 745, 748–49 (2008). 

17See, e.g., Md. Code Ann., Corps. and Ass’ns 

§ 2–405.1(a) (2008) (requiring a director to perform 

his duties: ‘‘(1) In good faith; (2) In a manner he 

reasonably believes to be in the best interests of the 

corporation; and (3) With the care that an ordinarily 

prudent person in a like position would use under 

similar circumstances.’’). 

18 15 U.S.C. 80a. See supra note 4. 

19See, e.g., Model Bus. Corp. Act Ann. § 8.30(b) 

(3d ed. 2002); Md. Code Ann., Corps. and Ass’ns 

§ 2–405.1(a)(3) (2008). 

20See, e.g., Smith v. Van Gorkom, 488 A.2d 858 

(Del. 1985) (explaining that, although directors are 

assumed to have been informed in making a 

business decision, when the burden of proving that 

a board was insufficiently informed is met, the 

board will have been found to have breached its 

duty of care). 

21See id. at 872 (discussing the standard for 

determining whether a director’s business judgment 

is informed). 

22See, e.g., Graham v. Allis-Chalmers 

Manufacturing Co., 188 A.2d 125, 130 (1963) 

(explaining that, under general principles of the 

common law, a director is entitled to rely on 

corporate summaries, reports, and records so long 

as he or she has not ‘‘recklessly reposed confidence 

in an obviously untrustworthy employee, [ ] refused 

or neglected cavalierly to perform his duty as a 

director, or [ ] ignored either willfully or through 

inattention obvious danger signs of employee 

wrongdoing.’’). A director should be satisfied not 

only that the person providing the report or opinion 

is doing so about a matter within his or her 

knowledge or expertise and has an appropriate 

basis for the opinion, but also that the scope of the 

directors are not required or expected to 

monitor each trade, they should monitor 

the adviser’s trading practices and the 

manner in which the adviser fulfills its 

obligation to seek best execution when 

trading fund portfolio securities.10 In 

doing so, the fund’s board should 

demand, and the fund’s adviser must 

provide, all information needed by the 

fund’s board to complete this review 

process.11 Without sufficient oversight 

by the fund’s board, transaction costs 

might inappropriately include payment 

for services that benefit the fund’s 

adviser at the expense of the fund and 

that the board believes should be paid 

directly by the adviser rather than with 

fund assets. 

We have received requests from fund 

directors for guidance on our view of 

their responsibilities in overseeing the 

activities of the investment advisers that 

trade their funds’ portfolio securities. 

These requests include inquiries as to 

how directors may properly fulfill their 

responsibilities with respect to 

overseeing an adviser’s satisfaction of its 

best execution obligations, including the 

adviser’s trade execution practices and 

the adviser’s use of fund brokerage 

commissions.12 Today we are proposing 

guidance with respect to information a 

fund board should request that an 

investment adviser provide to enable 

fund directors to determine that the 

adviser is fulfilling its fiduciary 

obligations to the fund and using the 

fund’s assets in the best interest of the 

fund. Our proposed guidance also is 

intended to assist the board in directing 

the adviser as to how fund assets should 

be used.13

Our proposed guidance would not 

impose any new or additional 

requirements. Rather, it is intended to 

assist fund directors in approaching and 

fulfilling their responsibilities of 

overseeing and monitoring the fund 

adviser’s satisfaction of its best 

execution obligations and the conflicts 

of interest that may exist when advisers 

trade the securities of their clients that 

are funds.14 In developing this proposed 

guidance, we have taken into account 

the wide variety of funds and advisers 

in terms of size, asset classes, 

complexity, and operations. We have 

also considered the changing market 

environment in the brokerage and 

investment management industries.15

We feel that with rapidly evolving 

market conditions and trading practices, 

it is appropriate to give guidance at this 

time. For these reasons, we are 

proposing guidance for fund directors to 

consider in performing their 

responsibilities and in determining 

what is appropriate in light of their 

fund’s particular circumstances. 

Our intention in this proposed 

guidance is to assist boards. We wish to 

provide guidance that is relevant, 

useful, and beneficial to fund directors 

in fulfilling their responsibilities to act 

in the best interest of investors in this 

area. We request comment on all aspects 

of our proposed guidance to help us in 

achieving this goal. In addition, as the 

evolving nature of brokerage practices 

greatly influences how directors 

approach their oversight responsibilities 

in this area, we specifically request 

comment on the current state of the 

brokerage and investment management 

industries and its effect on advisers’

trading of fund portfolio securities. 

II. Summary of Law Regarding 

Fiduciary Responsibilities of 

Investment Company Directors 

In fulfilling their responsibilities to a 

fund that they oversee, fund directors 

should understand the nature and 

source of their legal obligations to the 

fund and the fund’s shareholders. 

Because funds are generally formed as 

corporations, business trusts, or 

partnerships 16 under state law, fund 

directors and trustees, like other 

corporate directors, are subject to a 

‘‘duty of care’’ and a ‘‘duty of loyalty’’

under state and common law fiduciary 

principles,17 as well as the obligations 

imposed on them under the Investment 

Company Act.18

A director’s duty of care generally 

requires a fund director to perform his 

or her oversight responsibilities with the 

care of an ordinarily prudent person in 

a like position under similar 

circumstances.19 The duty of care thus 

establishes the degree of attention and 

consideration required of a director in 

matters related to the fund he or she 

oversees. As such, a director’s duty of 

care incorporates a duty to be informed, 

requiring that a director be reasonably 

informed about an issue before making 

a decision relating to that issue.20 To be 

reasonably informed about an issue, a 

director must inform him or herself of 

all material information regarding that 

issue reasonably available to him or 

her.21 In fulfilling these obligations, a 

fund director may rely on written and 

oral reports provided by management, 

auditors, fund counsel, the fund’s chief 

compliance officer (‘‘CCO’’), and other 

experts and committees of the board 

when making decisions, so long as the 

director reasonably believes that the 

reports are reliable and competent with 

respect to the relevant matters.22


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Federal Register / Vol. 73, No. 152 / Wednesday, August 6, 2008 / Proposed Rules 45649 

report bears on the matter being decided. See Van 

Gorkom, 488 A.2d at 875. In addition, to fulfill the 

duty of care, a director needs a well-informed 

decision-making process. This process may include, 

among other things, asking for and reviewing 

regular financial and other reports, questioning 

managers and outside experts about the meaning 

and implications of reports, and making inquiries 

when there are specific causes for concern. Id. 

23See, e.g., Strougo v. Scudder, Stevens and 

Clark, Inc., 964 F. Supp. 783, 801 (S.D.N.Y. 1997) 

(citing Md. Code Ann., Corps. and Assn’s § 2–

405.1(a)(1) (requiring corporate directors to perform 

their duties in ‘‘good faith’’) and James J. Hanks, Jr., 

Maryland Corporation Law § 6.6(b) (1995–1 Supp.) 

(explaining that a director’s duty to act in ‘good 

faith’ is generally synonymous with the duty of 

loyalty or the duty of fair dealing)). See also Pepper 

v. Litton, 308 U.S. 295, 310–311 (1939) (stating that 

a fiduciary ‘‘cannot serve himself first and his 

cestuis second’’). 

24See, e.g., Guth v. Loft, Inc., 5 A.2d 503, 510 

(Del. Ch. 1939) (‘‘Corporate officers and directors 

are not permitted to use their position of trust and 

confidence to further their private interests’’); see 

also Pepper, 308 U.S. at 310–311 (stating that a 

fiduciary ‘‘cannot use his power for his personal 

advantage and to the detriment of the stockholders 

and creditors no matter how absolute in terms that 

power may be and no matter how meticulous he is 

to satisfy technical requirements.’’). See also Fed. 

Regulation of Sec. Comm., Am. Bar Ass’n, Fund 

Director’s Guidebook 98 (3d ed. 2006) (‘‘Simply put, 

directors should not use their position for personal 

profit, gain, or other personal advantage.’’). 

25See, e.g., Strougo, 964 F. Supp. at 798 (holding 

that a fund shareholder has a private right of action 

under section 36(a) of the Investment Company Act 

against the independent directors of a fund for 

breach of fiduciary duty involving personal 

misconduct). See also Protecting Investors: A Half 

Century of Investment Company Regulation, 

Division of Investment Management 251 (May 1992) 

(‘‘Protecting Investors’’). 

26See Protecting Investors 251 n.3. 

27See Investment Company Act section 1(b)(2) 

[15 U.S.C. 80a–1(b)(2)]; U.S. Sec. and Exch. 

Comm’n, Report on Investment Trusts and 

Investment Companies, H.R. Doc No. 76–279, Part 

III (1939). See also Joseph F. Krupsky, The Role of 

Investment Company Directors, 32 BUS. LAW. 

1733, 1737–40 (1977); William J. Nutt, A Study of 

Mutual Fund Independent Directors, 120 U. Pa. L. 

Rev. 179, 181 (1971). 28See S. Rep. No. 91–184, at 4902–03 (1969) 

(‘‘The directors of a mutual fund, like directors of 

any other corporation will continue to have * * * 

overall fiduciary duties as directors for the 

supervision of all of the affairs of the fund.’’). 29 15 U.S.C. 80a–10(a). See also Burks v. Lasker, 

441 U.S. 471, 484–485 (1979) (‘‘Congress’ purpose 

in structuring the Act as it did is clear * * * it ‘was 

designed to place the unaffiliated directors in the 

role of ‘‘independent watchdogs.’’ ’ (quoting 

Tannenbaum v. Zeller, 552 F.2d 402 (2d Cir. 1977)). 30See Tannenbaum, 552 F.2d at 406 (noting that 

the independent director requirements under the 

Investment Company Act, in particular, were 

designed to ensure that ‘‘mutual funds would 

operate in the interest of all classes of [funds’] 

securities holders, rather than for the benefit of 

investment advisers, directors or other special 

groups.’’). 

31See 2006 Release at n.6 (citing Order Approving 

Proposed Rule Change and Related Interpretation 

under Section 36 of the Investment Company Act, 

Investment Company Act Release No. 11662 (Mar. 

4, 1981) [46 FR 16012 (Mar. 10, 1981)] (‘‘The 

directors of an investment company have a 

continuing fiduciary duty to oversee the company’s 

brokerage practices.’’)). See also Compliance 

Programs of Investment Companies and Investment 

Advisers, Advisers Act Release No. 2204 (Dec. 17, 

2003) [68 FR 74714 (Dec. 24, 2003)] (‘‘Compliance 

Release’’), at Section II.A.2.b (requiring that a fund’s 

board approve the policies and procedures of the 

fund’s service providers, including its investment 

adviser; the approval must be based on a finding by 

the board that the policies and procedures are 

reasonably designed to prevent violation of the 

Federal securities laws by the fund’s service 

providers). We have stated that we expect that the 

adviser’s compliance policies and procedures will 

address, to the extent that they are relevant, the 

adviser’s trading practices. See Compliance Release 

at II.A.1. 

32 Investment advisers are fiduciaries and have an 

obligation under the Investment Advisers Act of 

1940 [15 U.S.C. 80b] (‘‘Advisers Act’’) and state law 

to act in the best interest of their clients. See 

Restatement (Second) of Trusts § 170(1) (2008) 

(‘‘The trustee is under a duty to the beneficiary to 

administer the trust solely in the interest of the 

beneficiary’’); SEC v. Capital Gains Research 

Bureau, Inc., 375 U.S. 180, 191 (1963) (‘‘The 

Investment Advisers Act of 1940 thus reflects a 

congressional recognition ‘of the delicate fiduciary 

nature of an investment advisory relationship. 

* * * ’ ’’ (quoting 2 LOSS, Securities Regulation 

1412 (2d ed. 1961))); Transamerica Mortgage 

Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979) 

(noting that the legislative history of the Advisers 

Act ‘‘leaves no doubt that Congress intended to 

impose enforceable fiduciary obligations’’ on 

investment advisers). 

33See Capital Gains, 375 U.S. at 191, 196–197 

(‘‘The Investment Advisers Act of 1940 reflects 

* * * a congressional intent to eliminate, or at least 

to expose, all conflicts of interest which might 

incline an investment adviser, consciously or 

unconsciously, to render advice which was not 

disinterested.’’). 

A director’s duty of loyalty requires 

him or her to act in the best interests of 

the fund and the fund’s shareholders.23

The duty of loyalty encompasses a 

director’s obligations to avoid conflicts 

of interest with the fund and the fund’s 

shareholders, not to put his or her 

personal interests before the interests of 

the fund and the fund’s shareholders, 

and not to profit from his or her position 

as a fiduciary.24

In addition to statutory and common 

law obligations, fund directors are also 

subject to specific fiduciary obligations 

relating to the special nature of funds 

under the Investment Company Act.25

Unlike typical operating companies, 

funds ordinarily do not have any 

employees that are truly their own, but 

rather are generally formed and 

managed by a separately owned and 

operated sponsor, commonly an 

investment adviser.26 This external 

management structure of most funds 

may at times create conflicts of interest 

for investment advisers with clients that 

are funds. When it enacted the 

Investment Company Act, Congress 

recognized the potential for abuse 

created by the unique structure of 

funds.27 To protect fund shareholders, 

the Act requires that each registered 

fund be governed by a board of directors 

with the authority to supervise the 

fund’s operations.28 The Act further 

requires that at least 40 percent of a 

fund’s board be independent in order to 

serve as ‘‘independent watchdogs’’ in 

monitoring the fund’s managing 

organization.29 A fund board has the 

responsibility, among other duties, to 

monitor the conflicts of interest facing 

the fund’s investment adviser and 

determine how the conflicts should be 

managed to help ensure that the fund is 

being operated in the best interest of the 

fund’s shareholders.30

III. Board Oversight of Investment 

Adviser Trading Practices 

In overseeing the use of fund assets 

and in monitoring the conflicts of 

interest faced by a fund’s investment 

adviser, a fund board must consider the 

investment adviser’s practices when it 

trades the fund’s portfolio securities.31

A fund’s investment adviser is a 

fiduciary with respect to the fund and 

therefore must act in the fund’s best 

interest.32 Lower transaction costs 

generally are in the mutual interest of a 

fund’s adviser and the fund’s investors, 

and advisers typically seek to minimize 

transaction costs when trading fund 

securities so as not to detract from the 

fund’s performance. At times, however, 

there may be incentives for an 

investment adviser to compromise its 

fiduciary obligations to the fund in its 

trading activities in order to obtain 

certain benefits that serve its own 

interests or the interests of other clients. 

These conflicts of interest may exist, for 

example, when an adviser executes 

trades through an affiliate, when it 

determines the allocation of trades 

among its clients, and when it trades 

securities between clients. In addition, 

the use of fund brokerage commissions 

to pay for research and brokerage 

services may give incentives for advisers 

to disregard their best execution 

obligations when directing orders to 

obtain brokerage commission services. It 

also may give incentives for advisers to 

trade the fund’s securities in order to 

earn credits for fund brokerage 

commission services. In accordance 

with its fiduciary obligations and 

provisions of the Advisers Act, an 

adviser must make full and fair 

disclosure of these conflicts to a client 

and disclose how the adviser will 

manage each conflict before the adviser 

may engage in conduct that constitutes 

a conflict.33

The fund’s board, in providing its 

consent on the fund’s behalf, should be 

sufficiently familiar with the adviser’s 

trading practices to satisfy itself that the 

adviser is fulfilling its fiduciary 

obligations and is acting in the best 

interest of the fund. In some cases 

where the Commission has adopted 


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34See, e.g., Investment Company Act rule 10f–

3(c)(10) [17 CFR 270.10f–3(c)(10)] (fund boards 

must adopt procedures for purchases by the fund 

of securities from an affiliated underwriter and 

assess compliance on a quarterly basis); Investment 

Company Act rule 17a–7(e) [17 CFR 270.17a–7(e)] 

(fund boards must adopt procedures for purchases 

from and sales to affiliated funds and assess 

compliance on a quarterly basis); Investment 

Company Act rule 17a–8(a) [17 CFR 270.17a–8(a)] 

(fund boards must make certain determinations in 

evaluating mergers with affiliated funds); and 

Investment Company Act rule 17e–1(b) [17 CFR 

270.17e–1(b)] (fund boards must adopt procedures 

for brokerage transactions with affiliates and assess 

compliance on a quarterly basis). 35See, e.g., Prohibition on the Use of Brokerage 

Commissions to Finance Distribution, Investment 

Company Act Release No. 26591 (Sep. 2, 2004) [69 

FR 54728 (Sep. 9, 2004)], at section VII.E 

(explaining that the Commission’s adoption in 2004 

of Investment Company Act rule 12b–1(h) [17 CFR 

270.12b–1(h)], which, among other things, prohibits 

a fund from using brokerage commissions to pay for 

the distribution of the fund’s shares, was based on 

a conclusion that the practice of trading brokerage 

business for sales of fund shares poses conflicts of 

interest that the Commission believed to be ‘‘largely 

unmanageable’’). 

36See Interpretive Release Concerning the Scope 

of section 28(e) of the Securities Exchange Act of 

1934 and Related Matters, Exchange Act Release 

No. 23170 (Apr. 23, 1986) [51 FR 16004, 16011 

(Apr. 30, 1986)] (‘‘1986 Release’’), at Section V 

(explaining that an investment adviser has the 

obligation to seek ‘‘best execution’’ of a client’s 

transaction); Delaware Management Company, Inc., 

43 S.E.C. 392 (1967); Arleen W. Hughes, 27 S.E.C. 

629 (1948), aff’d sub nom. Hughes v. SEC, 174 F.2d 

969 (D.C. Cir. 1949). 

37 1986 Release at section V. 

38A fund may incur spread costs rather than 

commissions when a dealer trades with it on a 

principal basis. Spread costs are incurred indirectly 

when a fund either buys a security from a dealer 

at the ‘‘asked’’ price or higher or sells a security to 

a dealer at the ‘‘bid’’ price or lower. The difference 

between the bid price and the asked price is known 

as the ‘‘spread.’’ Spread costs include both an 

imputed commission on the trade as well as any 

market impact cost associated with the trade. Dealer 

spreads compensate broker-dealers for, among other 

things, maintaining a market’s trading infrastructure 

(i.e., price discovery and execution services), the 

broker-dealer’s cost of capital, and its assumption 

of market risk. Spreads may also reflect the impact 

of large orders on the price of a security. The 

proportion of these two components varies among 

different trades. Concept Release at section II.A.2. 

39 1986 Release at section V. 

40 Id. 

41See id. 

42For a more detailed discussion of explicit and 

implicit transaction costs, see Concept Release at 

section II.A. 

43See 1986 Release at section V (‘‘A money 

manager should consider the full range and quality 

of a broker’s services in placing brokerage 

including, among other things, the value of research 

provided. * * *’’). For further discussion regarding 

evaluation of broker-dealer research services, see 

infra section III.D. 

44For purposes of this release, our references to 

the term ‘‘dark pools’’ refer to markets that do not 

display quotes, but rather execute trades internally 

without displaying liquidity to other participants. A 

number of markets combine non-displayed liquidity 

with display of quotes. A substantial portion of the 

trading volume of these markets may result from 

interaction of orders with their non-displayed 

liquidity. See, e.g., Elizabeth Cripps, Shedding Light 

on the Dark Liquidity Pools, FTMandate, May 2007, 

available at http://www.ftmandate.com/news/ 

printpage.php/aid/1442/ 

Shedding_light_on_the_dark_liquidity_pools.html. 

45One recent report noted that although dark 

pools currently make up seven to ten percent of 

equities’ share volume in the U.S., that percentage 

is steadily increasing. Celent, LLC, Dark Liquidity 

Pools in Europe, Canada, and Japan: A U.S. 

Phenomenon Goes Abroad (2007). See also David 

Bogoslaw, Big Traders Dive Into Dark Pools, 

Business Week, Oct. 3, 2007, available at http:// 

www.businessweek.com/investor/content/oct2007/ 

pi2007102_394204.htm (noting that the Aite Group 

predicted in September 2007 that exchanges’

market share of U.S. equity trading would continue 

to decline from the current 75 percent, before 

stabilizing at around 62 percent by 2011, with 

alternative trading systems, including dark pools, 

intensifying fragmentation of the marketplace). 

46Execution costs may be lower on alternative 

trading systems. See, e.g., Jennifer Conrad, Kevin 

Johnson & Sunil Wahal, Insitutional Trading and 

Alternative Trading Systems, 70 J. of Fin. Econ. 99 

(2003). 

47For example, we understand that an adviser 

managing a fund that invests in companies with 

smaller capitalizations and more illiquid securities 

may need an executing broker-dealer to have 

experience and access to a particular market or one 

with expertise in a certain geographical area or 

industry. Advisers to these types of funds have 

indicated that they must rely on a relatively large 

number of brokers—especially where markets in 

niche securities have not developed on newer 

trading venues—to provide the execution and 

research they need with respect to a particular asset 

class. 

exemptive rules that permit funds to 

engage in transactions otherwise 

prohibited by the Investment Company 

Act, the Commission has imposed 

conditions designed to address certain 

conflicts of interest faced by advisers by 

mandating that directors take particular 

action in evaluating those conflicts.34 In 

other cases, the Commission has 

determined that the conflicts relating to 

a particular practice are unmanageable 

and has therefore prohibited advisers’

activities in that area altogether.35

Two specific areas where conflicts 

may arise when an adviser trades a 

fund’s portfolio securities concern the 

adviser’s obligation to seek best 

execution and to otherwise use fund 

assets, including brokerage 

commissions, in the best interest of the 

fund. The following sections provide 

guidance on the types of information a 

fund board should seek in order to 

evaluate whether the adviser to its fund 

has fulfilled its obligations to the fund 

with respect to these concerns. 

A. Board Oversight of an Investment 

Adviser’s Duty To Seek Best Execution 

and Consideration of Transaction Costs 

As a fiduciary to a client that is a 

fund, an investment adviser has the 

duty to seek best execution of securities 

transactions it conducts on the fund’s 

behalf.36 As we have stated previously, 

in seeking best execution, an investment 

adviser must seek to ‘‘execute securities 

transactions for clients in such a manner 

that the client’s total cost or proceeds in 

each transaction is the most favorable 

under the circumstances.’’ 37 In this 

regard, in seeking to maintain best 

execution on behalf of a client that is a 

fund, an adviser should consider factors 

beyond simply commission rates or 

spreads,38 including ‘‘the full range and 

quality of a broker’s services in placing 

brokerage. * * *’’ 39 These might 

include, among other things, the value 

of research provided, execution 

capability, financial responsibility, and 

responsiveness to the adviser.40

When trading portfolio securities of a 

client that is a fund, an adviser should 

consider factors related to minimizing 

the overall transaction costs incurred by 

the fund.41 Transaction costs consist of 

explicit costs that can be measured 

directly, such as brokerage 

commissions, fees paid to exchanges, 

and taxes paid, as well as implicit costs 

that are more difficult to quantify. 

Implicit costs, which may include, 

among other things, bid/ask spreads, the 

price impact of placing an order for 

trading in a security, and missed trade 

opportunity cost, may exceed greatly a 

transaction’s explicit costs.42 Price 

impact and opportunity cost can be 

influenced by a variety of factors—each 

of which should be considered by an 

investment adviser—such as the 

anonymity of the parties to the trade, 

the willingness of the intermediary to 

commit capital to facilitate the trade, 

and the speed and price of the 

execution. Investment advisers also can 

take into account the quality and utility 

of any research provided by the brokerdealer.43

An aspect of an adviser’s best 

execution process that directors should 

also consider is the adviser’s decision 

whether to use an alternative trading 

system. Newer trading venues, such as 

‘‘dark pools,’’ 44 and the use of advanced 

mathematical models or algorithmic 

trading systems, crossing networks, and 

other alternative trading systems, are 

increasingly prevalent.45 Although the 

use of such trading venues may provide 

funds certain benefits (such as 

potentially lower execution costs),46

they can also raise challenges to funds 

in certain situations.47

We ask for comment on how changes 

in the brokerage industry should affect 

a fund board’s oversight of the trading 

practices of the fund’s adviser. Is our 

discussion of the brokerage industry (as 

relevant to funds and their advisers) 

accurate? Are there other considerations 

with respect to the brokerage industry 

we should take into account? 

We understand that investment 

advisers with clients that are funds 

employ a wide range of procedures 


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48See infra note 77 and accompanying text 

(discussing the ‘‘broker vote’’ process employed by 

many advisers to evaluate broker-dealers’ brokerage 

and research services). 

49See Compliance Release at section I.A.1 

(explaining that, in mandating investment adviser 

compliance policies and procedures, we elected not 

to impose a single set of universally applicable 

required elements because advisers are too varied 

in their operations). 

50See 1986 Release at section V. 

51See Compliance Release at section II.A.1. Rule 

206(4)–7 under the Advisers Act [17 CFR 

275.206(4)–7] requires an investment adviser to 

have written compliance policies and procedures in 

place that are reasonably designed to prevent it 

from violating the Advisers Act and rules the 

Commission has adopted under the Act. The rule 

does not enumerate specific elements that an 

adviser must include in its policies and procedures. 

However, the Commission has stated that it expects 

an adviser, in designing its policies and procedures, 

to identify conflicts and other compliance factors 

creating risk exposure for the firm and its clients 

in light of the firm’s particular obligations, and then 

design policies and procedures that address those 

risks. See id. 

52 17 CFR 270.38a–1. See also Compliance 

Release at section II.A.2. 

53Although we are not suggesting that firms need 

to do so, we understand that some firms have 

employed third-party vendors to assist them in 

measuring best execution through a transaction cost 

analysis using comparative data from across the 

industry. We also have been informed that not all 

companies use the same methodology to measure 

trading costs and that there are no commonly 

accepted standards as to how to measure price 

impact. 

54Because sub-advisory arrangements take 

various forms, directors should have an 

understanding of the structure of these 

arrangements and whether the adviser is 

appropriately overseeing the trading activities of the 

sub-advisers. 

55 17 CFR 270.38a–1(a)(2)–(3) (requiring that each 

fund ‘‘[o]btain the approval of the fund’s board of 

directors * * * of the fund’s policies and 

procedures and those of each investment adviser 

* * * which approval must be based on a finding 

by the board that the policies and procedures are 

reasonably designed to prevent violation of the 

Federal Securities Laws by the fund, and by each 

investment adviser * * *’’ and that each fund 

‘‘review, no less frequently than annually, the 

adequacy of the policies and procedures of the fund 

and of each investment adviser. * * *’’). See also 

Compliance Release at section II.A.2. & II.B.2. 

56 17 CFR 270.38a–1(a)(4)(iii) (requiring that the 

fund designate a CCO who must, ‘‘no less than 

annually, provide a written report to the board that, 

at a minimum, addresses,’’ among other things, 

‘‘[t]he operation of the policies and procedures of 

the fund and each investment adviser. * * *’’). See 

also Compliance Release at section II.C.2. 

when selecting broker-dealers for fund 

securities transactions.48 In 

consideration of the wide variety of 

advisers in terms of size and operations, 

each adviser should determine what 

trading intermediary selection process is 

most appropriate for its 

circumstances.49 However, as the 

Commission has stated previously, in its 

process for choosing trading 

intermediaries, an adviser should 

periodically and systematically evaluate 

the performance of broker-dealers 

handling its transactions.50 In addition, 

the Commission has stated that an 

investment adviser should address its 

best execution obligations in the 

compliance policies and procedures that 

advisers are required to adopt and 

implement under rule 206(4)–7 under 

the Advisers Act.51 Rule 38a–1 under 

the Investment Company Act requires 

that the policies and procedures of a 

fund adviser be approved by the fund 

board based on the board’s finding that 

the policies and procedures are 

reasonably designed to prevent the 

adviser’s violation of the Federal 

securities laws.52

Fund directors should seek relevant 

data from the fund’s investment adviser 

to assist them in evaluating the adviser’s 

procedures regarding its best execution 

obligations. These data should typically 

include, but not be limited to: (i) The 

identification of broker-dealers to which 

the adviser has allocated fund trading 

and brokerage; (ii) the commission rates 

or spreads paid; (iii) the total brokerage 

commissions and value of securities 

executed that are allocated to each 

broker-dealer during a particular period; 

and (iv) the fund’s portfolio turnover 

rates. Fund boards may also discuss 

related matters with the adviser, which 

may include the following, where 

applicable: 

• The process for making trading 

decisions and the factors involved in the 

selection of execution venues and the 

selection of broker-dealers; 

• The means by which the investment 

adviser determines best execution and 

evaluates execution quality as well as 

how best execution is affected by the 

use of alternative trading systems; 

• Who negotiates commission rates, 

how that negotiation is carried out, 

whether the amount of commissions 

agreed to depends on comparative data 

with respect to commission rates, and 

generally how transactions costs are 

measured; 53

• How the quality of ‘‘executiononly’’ trades—trades that do not include 

payment for any additional research or 

services beyond execution—is evaluated 

compared to that of other trades (for 

example, whether trades that are 

executed through channels that include 

an additional soft dollar component are 

reviewed in comparison with executiononly trades to discern any discrepancies 

in the quality of execution); 

• How the performance of the 

adviser’s traders is evaluated, as well as 

the aggregate performance of the firm’s 

traders as a whole, how the performance 

of each broker-dealer the adviser uses 

for fund portfolio transactions is 

evaluated, and how problems or 

concerns that are identified with a 

trader or a broker-dealer are addressed; 

• If sub-advisers are used, how the 

adviser provides oversight and monitors 

each sub-adviser’s activities, including 

the trading intermediary selection 

process; 54

• To what extent and under what 

conditions the adviser conducts 

portfolio transactions with affiliates; 

• The process for trading fixedincome securities and determining the 

costs of fixed income transactions; 

• How the quality of trade execution 

is evaluated with respect to fixedincome and other instruments traded on 

a principal basis; and 

• If there are international trading 

activities, how these trades are 

conducted and monitored. 

We acknowledge that not all funds 

would require an evaluation of each of 

these factors by their boards. Different 

factors may be appropriate for different 

funds, depending on a fund’s 

investment objective, trading practices, 

and personnel. 

We also request comment regarding 

how boards should approach their 

obligations to oversee and evaluate the 

fund adviser’s trading practices and 

procedures. Is there further information 

fund boards should request that the 

adviser provide to assist directors in 

their review? 

Once the board receives from the 

adviser information with respect to the 

issues outlined above, fund directors 

should determine whether the adviser’s 

trading practices are being conducted in 

the best interests of the fund and the 

fund’s shareholders. If these interests 

are not being best served, the board 

should direct the adviser accordingly. 

In addition, when an investment 

adviser seeks the fund board’s approval 

of the adviser’s compliance policies and 

procedures, directors should satisfy 

themselves that the adviser’s policies 

and procedures are reasonably designed, 

adequate, and being effectively 

implemented to prevent violations of 

the Federal securities laws.55 Directors 

may evaluate the adviser’s compliance 

policies and procedures through 

updates from different sources, which 

may include the fund’s or the adviser’s 

CCO or other appropriate sources.56

Furthermore, with the rapid 

development of increased options for 

trading venues, fund boards need to 

remain up to date in their familiarity 

with the evolving market in this area. 

We understand that fund directors 

approach educating themselves on 


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57Some ways we have observed that directors 

educate themselves on developments in this area 

include: (i) Establishing a committee of the board 

to specialize in portfolio trading practices; (ii) 

requiring that the adviser form special committees 

to consider best execution and the use of client 

commissions and to provide reports to the board on 

the adviser’s trading activities; (iii) requesting 

periodic summaries and analyses from officers of 

the adviser to explain the adviser’s portfolio trading 

practices; (iv) attending trade association events, 

seminars and/or other education events relating to 

brokerage practices; (v) subscribing to third-party 

information providers or retaining experts to ensure 

that board members remain knowledgeable with 

respect to market developments; and (vi) 

periodically meeting with portfolio managers, 

business unit staff, trading personnel and other 

employees of the adviser. 

58See Thomas P. Lemke & Gerald T. Lins, Soft 

Dollars and Other Brokerage Arrangements 

§ 1.04[A] (2005). Proprietary research is often 

provided to an investment adviser partly as a quid 

pro quo for brokerage business given by the adviser 

to the broker producing the research. Alternatively, 

proprietary research may be provided without being 

expressly requested and considered part of the 

services obtained in exchange for ‘‘full service,’’ or 

‘‘bundled,’’ commissions that include a sufficient 

amount of compensation to cover the cost of 

research. Id. 

59See id. 

60See 2006 Release at section III (interpreting 

section 28(e) to permit the industry flexibility to 

structure arrangements that are consistent with the 

statute and best serve investors). 

61See infra note 70 (explaining that only 

commission-based trades (as opposed to mark-ups 

or mark-downs or spreads) are covered under the 

safe harbor in section 28(e) of the Exchange Act). 

62 In expense reimbursement arrangements, also 

referred to as ‘‘brokerage/service arrangements,’’ a 

broker-dealer typically agrees to pay a fund’s 

service provider fees (such as custodian fees or 

transfer agency fees) and, in exchange, the fund 

agrees to direct a minimum amount of brokerage 

business to the reimbursing broker. The fund 

adviser usually negotiates the terms of the contract 

with the service provider, and the fees charged 

under the contract are paid directly by the brokerdealer. Brokerage/service arrangements may be 

structurally similar to client commission 

arrangements. However, unlike client commission 

arrangements, where the receipt of a benefit by the 

investment adviser through the use of fund 

brokerage commissions gives rise to conflicts of 

interest, brokerage/service arrangements generally 

do not raise these concerns because they typically 

involve the use of fund brokerage commissions to 

obtain services that directly and exclusively benefit 

the fund. See Payment for Investment Company 

Services with Brokerage Commissions, Securities 

Act Release No. 7197 (July 21, 1995) [60 FR 38918 

(July 28, 1995)] (‘‘1995 Release’’), at nn. 1–2 and 

accompanying text; see also 2006 Release at section 

II.A, n.27. 

63 15 U.S.C. 80a–17(e)(1). Section 17(e)(1) of the 

Investment Company Act generally makes it 

unlawful for any affiliated person of a registered 

investment company to receive any compensation 

(other than a regular salary or wages from the 

company) for the purchase or sale of any property 

to or for the investment company when that person 

is acting as an agent other than in the course of that 

person’s business as a broker-dealer. Essentially, 

section 17(e)(1) may be violated if an affiliated 

person of a registered investment company, such as 

an adviser, receives compensation (other than a 

regular salary or wages from the company) for the 

purchase or sale of property to or from the 

investment company. Absent the protection of 

section 28(e), which provides a safe harbor from 

liability under other federal and state law, an 

investment adviser’s receipt of compensation—

including in the form of brokerage or research 

services—under a client commission arrangement 

for the purchase or sale of any property, including 

securities, for or to the investment company, may 

constitute a violation of section 17(e)(1). See U.S. 

v. Deutsch, 451 F.2d 98, 110–11 (2d Cir. 1971), cert. 

denied, 404 U.S. 1019 (1972). If a fund adviser’s 

client commission arrangement is not consistent 

with section 28(e), disclosure of the arrangement 

would not cure any section 17(e)(1) violation. See 

2006 Release at n.31; 1986 Release at n.55. 

64An adviser’s obligation to act in the best 

interest of its client imposes a duty on the adviser 

not to profit at the expense of the client without the 

client’s consent. See, e.g., Restatement (Second) of 

Trusts § 170 cmt. a, § 216 (1959). Also, section 206 

of the Advisers Act establishes federal fiduciary 

standards governing the conduct of investment 

advisers. Under sections 206(1) and (2), in 

particular, an adviser must discharge its duties in 

the best interest of its clients, and must fully 

disclose a conflict of interest with a client, before 

engaging in conduct that constitutes a conflict. See 

Transamerica, 444 U.S. at 17. 

industry developments in various 

ways.57

B. Board Oversight of an Investment 

Adviser’s Use of Fund Brokerage 

Commissions 

When trading portfolio securities on 

behalf of clients that are funds, there are 

a number of ways in which an 

investment adviser may use a portion of 

fund brokerage commissions to benefit 

the fund beyond execution of the 

securities transaction. First, a fund 

adviser may use a portion of fund 

brokerage commissions to purchase 

research and/or research-related 

services in accordance with section 

28(e) of the Exchange Act. The research 

may be ‘‘proprietary’’ research, 

produced by the broker-dealer executing 

the securities transaction or its 

affiliates,58 or it may be ‘‘third-party 

research,’’ produced or provided by 

someone other than the executing 

broker-dealer.59 Investment advisers 

also may purchase third-party research 

themselves using cash payments from 

their own account, or ‘‘hard dollars.’’

Furthermore, investment advisers may 

obtain proprietary and third-party 

research through a ‘‘client commission 

arrangement.’’ In a client commission 

arrangement, an investment adviser 

agrees with a broker-dealer effecting 

trades for the adviser’s client accounts 

that a portion of the commissions paid 

by the accounts will be credited to 

purchase research either from the 

executing broker or another broker, as 

directed by the adviser.60

In addition to obtaining research and 

research-related services with fund 

brokerage commissions,61 an adviser 

may use fund brokerage commissions in 

other ways. For example, an adviser 

may utilize a commission recapture 

arrangement, whereby the fund receives 

a portion, or rebate, of the brokerage 

commission (or spread) charged by the 

broker-dealer handling the trade. 

Additionally, an investment adviser 

may use fund brokerage to pay certain 

providers for services utilized by the 

fund through an expense reimbursement 

arrangement with a broker-dealer and/or 

its affiliates.62

We specifically request comment on 

our discussion of the various uses of 

fund brokerage. Have we described the 

use of fund brokerage commissions and 

client commissions by advisers 

correctly? Are fund brokerage 

commissions used in ways that we have 

not addressed but should address in this 

proposed guidance? 

Because fund brokerage commissions 

are fund assets, investment advisers 

have a conflict of interest when they use 

commissions to obtain research and 

related services that they would 

otherwise have to pay for themselves. 

Advisers therefore are subject to certain 

requirements when using fund 

brokerage in this manner. First, section 

17(e)(1) of the Investment Company Act 

prohibits investment advisers to 

registered investment companies from 

using soft dollars to obtain research or 

services outside the confines of the safe 

harbor provided by section 28(e) of the 

Exchange Act.63 Second, investment 

advisers, as fiduciaries, generally are 

prohibited from receiving any benefit 

from the use of fund assets,64 although 

an investment adviser’s use of soft 

dollars creates opportunities for the 

adviser to benefit in ways that may not 

be in the best interest of the fund. These 

conflicts of interest arise in a number of 

ways when investment advisers use 

fund assets in soft dollar programs. For 

example: 

• The use of fund brokerage 

commissions to buy research may 

relieve an adviser of having to produce 

the research itself or having to pay for 

the research with ‘‘hard dollars’’ from 

its own resources; 

• The use of soft dollars may give an 

adviser an incentive to compromise its 

fiduciary obligations and to trade the 

fund’s portfolio in order to earn soft 

dollar credits; 

• The availability of soft dollar 

benefits that an adviser may receive 

from fund brokerage commissions 

creates an incentive for an adviser to use 

broker-dealers on the basis of their 

research services provided to the 

adviser rather than the quality of 

execution provided in connection with 

fund transactions; 

• An adviser may seek to use fund 

brokerage commissions to obtain 


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65See infra section III.E (discussing the 

obligations of fund advisers and fund boards under 

section 15(c) of the Investment Company Act). 

66Although these types of arrangements do not 

involve the conflicts posed by soft dollars, they do 

raise issues related to how a fund’s assets are being 

expended and other issues, such as disclosure. See 

Concept Release at section VI. 

67For a discussion of ‘‘mixed-use’’ items, see 

1986 Release at section II.B and 2006 Release at 

section III.F. These releases stated, as an example 

of a product that may have a mixed use, 

management information services (which may 

integrate trading, execution, accounting, 

recordkeeping, and other administrative matters 

such as measuring the performance of accounts). In 

the 1986 Release, the Commission indicated that 

where a product has a mixed use, an investment 

adviser should make a reasonable allocation of the 

cost of the product according to its use, and should 

keep adequate books and records concerning the 

allocations. The Commission also stated: (i) That 

the allocation decision itself poses a conflict of 

interest for the investment adviser that should be 

disclosed to the client; and (ii) that an investment 

adviser may use client commissions pursuant to 

section 28(e) of the Exchange Act to pay for the 

portion of a service or specific component that 

assists the adviser in the investment decisionmaking process, but cannot use soft dollars to pay 

for that portion of a service that provides the 

adviser with administrative assistance. 1986 

Release at Section II.B. The 2006 Release made clear 

that ‘‘brokerage’’ products and services, as defined 

in the release, may also require a mixed-use 

allocation. 2006 Release at nn.72–73. For a 

discussion of section 28(e) of the Exchange Act, see 

infra section III.C. 

68Fund boards are not required to approve 

brokerage and research services simply because 

they fall within the section 28(e) safe harbor. 

Rather, board determinations regarding the 

purchase of brokerage and research services with 

fund brokerage commissions should be made in 

accordance with the fund’s best interest. In this 

regard, section 28(e) contemplates that funds could 

enter into contracts to reduce or eliminate an 

adviser’s ability to rely on the safe harbor. See 

Thomas P. Lemke & Gerald T. Lins, Soft Dollars and 

Other Brokerage Arrangements § 4.09 (2005) (‘‘[T]he 

language of the safe harbor itself recognizes that the 

parties to an investment management relationship 

may by contract opt out of Section 28(e).’’); see also 

Section 28(e) of the Exchange Act [15 U.S.C. 

78bb(e)(1)] (stating that the safe harbor does not 

apply where ‘‘expressly provided by contract’’). 

69 15 U.S.C. 78bb(e)(1). When fixed commission 

rates were abolished in 1975, investment advisers 

and broker-dealers expressed concern that, if an 

investment adviser were to cause a client account 

to pay more than the lowest commission rate 

available for a particular transaction, then the 

adviser would be exposed to charges that it had 

breached its fiduciary duty owed to its client. 

Congress addressed this concern by enacting 

section 28(e). See 2006 Release at section II.A. 

70See supra note 63. It should be noted that 

section 28(e) of the Exchange Act does not 

encompass trades that are not executed on an 

agency basis, principal trades (with the exception 

of certain riskless principal transactions as 

described below), or other instruments traded net 

with no explicit commissions. See 2006 Release at 

n.27. However, the Commission has interpreted the 

term ‘‘commission’’ in section 28(e) as 

encompassing fees on certain riskless principal 

transactions that are reported under the trade 

reporting rules of the Financial Industry Regulatory 

Authority, or FINRA (as successor to the National 

Association of Securities Dealers, or NASD). See 

Commission Guidance on the Scope of section 28(e) 

of the Exchange Act, Exchange Act Release No. 

45194 (Dec. 27, 2001) [67 FR 6 (Jan. 2, 2002)], at 

Section II. 71See 2006 Release at section III. 72See supra note 52 and accompanying text 

(discussing a fund board’s obligation to approve an 

adviser’s compliance policies and procedures). 73See 2006 Release at Section III.B. 74See id. 

75See 2006 Release at n.150 and accompanying 

text (citing House Comm. on Interstate and Foreign 

Commerce, Securities Reform Act of 1975 (H.R. 

4111), H.R. Rep. No. 94–123, at 95 (1975) (‘‘It is, 

of course, expected that money managers paying 

brokers an amount [of commissions] which is based 

upon the quality and reliability of the broker’s 

services including the availability and value of 

research, would stand ready and be required to 

demonstrate that such expenditures were bona 

fide.’’)); see also 1986 Release at Section IV.B.3 

(explaining that, among the responsibilities of the 

disinterested directors of a fund may be to monitor 

the adviser’s soft dollar arrangements). 

research that benefits the adviser’s other 

clients, including clients that do not 

generate brokerage commissions (such 

as fixed-income funds), those that are 

not otherwise paying more than the 

lowest available commission rate in 

exchange for soft dollar products or 

services (i.e., ‘‘paying up’’ in 

commission costs), or those from which 

the adviser receives the greatest amount 

of compensation for its advisory 

services; 

• The use of soft dollars may disguise 

an adviser’s true costs and enable an 

adviser to charge advisory fees that do 

not fully reflect the costs for providing 

the portfolio management services; 65

• The use of fund brokerage 

commissions to obtain research and 

other services may cause an adviser to 

avoid other uses of fund brokerage 

commissions that may be in the fund’s 

best interest, such as establishing a 

commission recapture program or fund 

expense reimbursement arrangement to 

offset expenses that are paid for with 

fund assets; 66 and 

• In the case of ‘‘mixed-use’’

products—for example, research 

products or services obtained using soft 

dollars that may serve functions that are 

not related to the investment decisionmaking process, such as accounting or 

marketing—an adviser has a conflict 

when making an allocation 

determination between the research and 

non-research uses of the product as 

required to fulfill the requirements 

under section 28(e) of the Exchange 

Act.67

When evaluating an adviser’s use of 

fund brokerage commissions in light of 

these conflicts, a fund board may 

determine that such use is in the best 

interests of the fund.68

C. Section 28(e) Under the Securities 

Exchange Act of 1934 

Section 28(e) of the Exchange Act 

provides a safe harbor that protects 

investment advisers from liability for a 

breach of fiduciary duty solely on the 

basis that the adviser caused an account 

over which it exercises investment 

discretion to pay more than the lowest 

commission rate in order to receive 

brokerage and research services 

provided by a broker-dealer, if the 

adviser determined in good faith that 

the amount of the commission was 

reasonable in relation to the value of the 

brokerage and research services 

received.69 As we have stated, section 

17(e)(1) of the Investment Company Act 

prohibits investment advisers to 

registered investment companies from 

obtaining brokerage and research 

services with fund brokerage 

commissions outside the section 28(e) 

safe harbor.70

The 2006 Release provides guidance 

with respect to the appropriate 

framework for analyzing whether a 

particular service falls within the 

‘‘brokerage and research services’’ safe 

harbor of section 28(e).71 A fund board 

should request that the fund adviser 

inform directors of the policies and 

procedures the adviser uses to ensure 

that the types of brokerage and research 

services the adviser obtains using fund 

brokerage commissions fall within the 

safe harbor and that the adviser has not 

engaged in excessive trading in light of 

the fund’s investment objectives. In 

turn, in approving the policies and 

procedures, a board should consider 

whether they are reasonably designed to 

ensure that the adviser’s use of fund 

brokerage commissions complies with 

the section 28(e) safe harbor, as well as 

all the federal securities laws.72

In addition, as we stated in the 2006 

Release, to rely on the section 28(e) safe 

harbor, an adviser must: (i) Determine 

whether the product or service obtained 

is eligible research or brokerage under 

section 28(e); (ii) determine whether the 

eligible product actually provides 

lawful and appropriate assistance in the 

performance of his investment decisionmaking responsibilities; and (iii) make a 

good faith determination that the 

amount of client commissions paid is 

reasonable in light of the value of 

products or services provided by the 

broker-dealer.73 We also reaffirmed an 

investment adviser’s essential obligation 

under section 28(e) to make this good 

faith determination and that the burden 

in demonstrating this determination 

rests on the investment adviser.74 An 

adviser should demonstrate to the board 

that it has met this burden.75 We 

specifically request comment on our 

proposed guidance in this regard. We 

also request examples of effective 

practices fund boards employ when 

evaluating whether an adviser has made 


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76See supra note 68 and accompanying text. 

77Advisers have informed us that, although many 

employ a broker vote, the actual process of 

determining which brokers to use varies among 

firms, as do the factors upon which each firm’s 

voting system is based. Often a system of rating or 

allocating points is used to set targets for each 

broker, with the better-rated brokers receiving 

additional orders. Other firms have substantially 

less formal broker-selection processes. 

78As we stated in the 2006 Release, in allocating 

costs for a particular product or service, a money 

manager should make a good faith, fact-based 

analysis of how it and its employees use the 

product or service. It may be reasonable for an 

investment adviser to infer relative costs from 

relative benefits to the firm or its clients. Relevant 

factors might include, for example, the amount of 

time the product or service is used for eligible 

purposes versus non-eligible purposes, the relative 

utility (measured by objective metrics) to the firm 

of the eligible versus non-eligible uses, and the 

extent to which the product is redundant with other 

products employed by the firm for the same 

purpose. See 2006 Release at section III.F, n.148. 

79We believe that the availability of electronic 

methods to order, track, and analyze securities 

trading may make it easier to determine whether 

client commission arrangements benefit a fund. 

With electronic trading, advisers and fund boards 

may be able to determine the costs associated with 

trade execution, as well as the expense of research 

paid for with fund brokerage commissions, with 

greater certainty. Also, to the extent that they 

incorporate transparency mechanisms such as the 

invoicing of costs for particular research products 

and services, the use of certain client commission 

arrangements may enable fund boards to more 

clearly determine the actual amount of commission 

dollars used to pay for research and those used to 

pay for execution. 

80The staff has outlined some of the specific 

information fund boards have reviewed with 

respect to soft dollar arrangements. See Inspection 

Report on the Soft Dollar Practices of BrokerDealers, Investment Advisers and Mutual Funds, 

Office of Compliance, Inspections and 

Examinations (Sept. 1998), available at http:// 

www.sec.gov/news/studies/softdolr.htm (‘‘1998 

Staff Report’’), at Appendix G. 

the good faith determination required 

under section 28(e). 

D. An Investment Adviser’s General 

Fiduciary Obligations to Clients that Are 

Funds When Using Soft Dollars 

As we have stated, although a fund 

adviser may satisfy the requirements for 

using client commissions to pay for 

brokerage and research services under 

the section 28(e) safe harbor, a fund’s 

directors still should evaluate the 

adviser’s use of fund brokerage 

commissions to purchase research and 

services in order to determine whether 

the adviser is acting in the best interest 

of the fund. If a fund board determines 

that the adviser’s use of brokerage 

commissions is not in the best interest 

of the fund, the board should prohibit 

or limit the use of fund brokerage 

commissions and direct the adviser 

accordingly.76

In this regard, directors need to 

understand the procedures that the 

fund’s investment adviser employs to 

address any potential conflicts of 

interest and ensure that fund 

commissions are being used 

appropriately. For example, to try to 

address concerns that a broker-dealer 

may be chosen by an adviser for reasons 

other than the quality of the brokerdealer’s execution (including the 

brokerage and research services it 

provides), some advisers, particularly 

larger ones, may use an internal process 

referred to as a ‘‘broker vote’’ or ‘‘broker 

tolls,’’ whereby the adviser’s investment 

professionals, typically the portfolio 

managers and investment analysts, 

assess the value of the research and 

services different broker-dealers provide 

to determine which broker-dealer’s 

research and other services the adviser 

should purchase.77

To assist the board in understanding 

the adviser’s policies and procedures 

regarding the use of fund brokerage 

commissions to obtain brokerage and 

research services, the board should 

request that the adviser inform the 

directors as to such matters as the 

following: 

• How does the adviser determine the 

total amount of research to be obtained 

and how will the research actually be 

obtained? In particular: 

• How does the adviser determine the 

amount to be spent using hard versus 

soft dollars? 

• How does the adviser determine 

amounts to be spent on proprietary 

versus third-party research 

arrangements? 

• What types of research products 

and services will the adviser seek to 

obtain and how will this research be 

beneficial to the fund? 

• How does the adviser determine 

amounts to be used in commission 

recapture programs and expense 

reimbursement programs? 

• What is the process for establishing 

a soft dollar research budget and 

determining brokerage allocations in the 

soft dollar program? Is a broker vote 

process or some other mechanism used? 

• Do any alternative trading venues 

that are used produce soft dollar 

credits? If so, how much? 

• How does the adviser determine 

that the use of soft dollars is within the 

section 28(e) safe harbor? In particular: 

• Is the product or service obtained 

eligible brokerage or research, as 

defined under section 28(e)? 

• Does the product or service provide 

lawful and appropriate assistance to the 

adviser in carrying out its investment 

decision-making responsibilities? 

• Is the amount of commissions paid 

reasonable (based upon a good faith 

determination) in light of the value of 

brokerage and research services 

provided by the broker-dealer? 

• How does soft dollar usage compare 

to the adviser’s total commission 

budget? 

• How are soft dollar products and 

services allocated among the adviser’s 

clients? Are the commissions paid for 

certain trades in fund portfolio 

securities similar to commissions paid 

for transactions in similar securities, or 

of similar sizes, by the fund and the 

adviser’s other clients (including clients 

that are not funds)? Are other clients 

paying lower commissions that do not 

include a soft dollar component? If so, 

does the adviser adequately explain the 

discrepancy in commission rates and 

provide the board data sufficient to 

satisfy the board that the fund is not 

subsidizing the research needs of the 

adviser’s other client? To what extent 

are the products and services purchased 

through soft dollar arrangements used 

for the benefit of fixed-income or other 

funds that generally do not pay 

brokerage commissions? 

• What is the process for assessing 

the value of the products or services 

purchased with soft dollars? 

• What is the process used to evaluate 

the portion of a mixed use product or 

service that can be paid for under 

section 28(e)? 78

• To what extent does the adviser use 

client commission arrangements? What 

effect do these arrangements have on 

how the adviser selects a broker-dealer 

to complete a particular transaction? 

How does the adviser explain that the 

use of client commission arrangements 

benefits the fund? 79

We request comment on the 

information boards should receive to 

facilitate their review of an adviser’s use 

of soft dollars.80 Should boards request 

any further information from advisers in 

this regard? Should boards employ any 

specific alternative approaches or 

analyses when reviewing an adviser’s 

soft dollar usage? Is further guidance 

needed with respect to how a board 

should approach reviewing an adviser’s 

soft dollar usage? 

As with the adviser’s trading 

practices, after receiving appropriate 

input and information from the adviser, 

if the board believes that the fund’s 

brokerage commissions could be used 

differently so as to provide greater 

benefits to the fund, the board should 

direct the adviser accordingly. For 

example, the adviser should explain to 

the board that the value the fund 

receives from the brokerage and 

research services purchased with fund 

brokerage commissions is appropriate, 


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81The Commission has stated that, in addition to 

an adviser’s general best execution obligations, the 

compliance policies and procedures advisers are 

required to adopt and implement under rule 

206(4)–7 of the Advisers Act should address the 

adviser’s uses of client brokerage to obtain research 

and other services. See Compliance Release at 

Section II. 

82 In this regard, fund boards may look to, among 

other sources, the fund’s CCO to provide assistance 

with evaluating any potential conflicts of interest 

with respect to the adviser’s brokerage practices and 

determining how those conflicts should be 

addressed. See Compliance Release at section 

II.A.2.b. 

83See 1986 Release at section V. An adviser 

should consider the full range and quality of the 

broker’s services, including the value of research 

provided, in assessing whether a broker will 

provide best execution. 

84As suggested above, failure by an investment 

adviser to disclose material conflicts of interest to 

its clients may constitute fraud within the meaning 

of sections 206(1) and (2) of the Advisers Act. See 

supra note 64. See also Capital Gains, 375 U.S. at 

191–193, 200–01 (noting that ‘‘suppression of 

information material to an evaluation of the 

disinterestedness of an investment adviser’’ may 

operate ‘‘as a deceit on purchasers.’’). 

85 15 U.S.C. 80a–15(c). Section 15(c) makes it 

unlawful for an investment company to enter into 

or renew an investment advisory contract unless it 

is approved by a majority of the company’s 

disinterested directors. 

86See 2006 Release; 1986 Release. In connection 

with the board’s section 15(c) review of the 

advisory contract, section 36(b) of the Investment 

Company Act imposes a fiduciary duty on fund 

advisers with respect to their receipt of 

compensation for services or payments of a material 

nature from the fund or its shareholders. 15 U.S.C. 

80a–36(b). In determining whether an adviser has 

breached its obligations under section 36(b), the 

seminal case of Gartenberg v. Merrill Lynch Asset 

Mgmt., Inc., 694 F.2d 923 (2d Cir. 1982), suggests 

that all of the facts and circumstances surrounding 

the adviser’s relationship with the fund are 

appropriate for director consideration in approving 

the advisory contract. To the extent an adviser 

receives benefits from the use of soft dollars that are 

of ‘‘sufficient substance,’’ these benefits should be 

disclosed and considered by the fund’s board of 

directors. Id. at 932–933 (stating that ‘‘estimates of 

* * * ‘fall-out’ and ‘float benefits’ which, while not 

precise, could be a factor of sufficient substance to 

give the Funds’ trustees a sound basis for 

negotiating a lower Manager’s fee.’’). 

87Section 15(a)(1) of the Investment Company 

Act, which makes it unlawful for any person to 

serve as an investment adviser of a registered 

investment company except pursuant to a written 

contract which has been approved by a majority 

vote of shareholders and which ‘‘precisely describes 

all compensation’’ to be paid under that contract, 

also should be considered with regard to soft dollar 

arrangements. 15 U.S.C. 80a–15(a)(1). See 1986 

Release at n.40. 

88See 1998 Staff Report at 36. Examinations 

conducted since the 1998 Staff Report continue to 

document wide variations in the fund board review 

process. For example, our inspection staff has 

observed that, in certain cases, a fund board has not 

obtained the information necessary to evaluate soft 

dollar arrangements in the context of the board’s 

section 15(c) review. 

and whether the services are 

inappropriately benefiting another of 

the adviser’s clients at the fund’s 

expense. In directing the adviser, the 

board also should consider such matters 

as: (i) Whether it is appropriate for the 

adviser to refrain from purchasing 

research services in connection with 

certain types of trades, depending on 

market conditions; (ii) whether it is 

appropriate for the adviser to use fund 

brokerage commissions to receive 

brokerage and research services on some 

or all trades; (iii) whether fund 

brokerage commissions should be used 

only in connection with a commission 

recapture or expense reimbursement 

program; and (iv) whether some 

combination of these alternatives may 

be in the best interest of the fund. 

In addition, fund boards should 

inquire as to how the adviser’s 

compliance policies and procedures 

with respect to soft dollars are 

determined and monitored.81 In 

deciding whether to approve these 

policies and procedures, directors 

should consider, and the investment 

adviser should explain, how the policies 

and procedures eliminate or otherwise 

mitigate the conflicts of interest that 

exist when an adviser trades portfolio 

securities on the fund’s behalf.82

Furthermore, the value of research 

obtained through the use of soft dollars 

is a factor a fund board should consider 

when determining whether an 

investment adviser has fulfilled its best 

execution obligations.83 The conflicts of 

interest inherent in soft dollar 

arrangements require boards to pay 

particular attention to investment 

advisers’ activities in this regard to 

ensure that fund assets are being used 

appropriately on behalf of the fund.84

We request comment on our proposed 

guidance in regard to how a fund board 

should approach its review of an 

adviser’s use of soft dollars and the 

adviser’s applicable policies and 

procedures to ensure that the conflicts 

of interest inherent in these transactions 

are being managed. 

E. Section 15(c) Under the Investment 

Company Act 

In addition to their oversight and 

monitoring responsibilities with respect 

to portfolio trading and the conflicts of 

interest associated with soft dollar 

programs, fund directors have an 

obligation to review the adviser’s 

compensation. This requirement stems 

from the requirement in section 15(c) of 

the Investment Company Act that the 

independent members of the board 

review the fund’s investment advisory 

contract on an annual basis.85 A fund 

board’s review of the adviser’s 

compensation under section 15(c) 

should incorporate consideration of soft 

dollar benefits that the adviser receives 

from fund brokerage.86 In considering 

the advisory contract for approval, fund 

boards are required under section 15(c) 

to request and evaluate such 

information as may reasonably be 

necessary to evaluate the terms of the 

contract, and the adviser to the fund has 

the obligation to furnish to the board the 

information necessary to review the 

contract.87

Although fund boards typically 

review the use of fund brokerage by the 

adviser (including the adviser’s use of 

soft dollars) during the contract review 

process, Commission examinations 

show wide variations in board practices 

in this area.88 In many cases, fund 

boards are provided with Part II of the 

adviser’s Form ADV. While Form ADV 

provides important information 

regarding the investment adviser, the 

Form ADV disclosure requirement was 

not designed for the purpose of 

providing fund directors with all of the 

information needed to help them satisfy 

board obligations under section 15(c) of 

the Investment Company Act. In order 

to fulfill their obligations in connection 

with the section 15(c) review process, 

fund boards often seek additional 

information on soft dollars. However, 

the types of additional information a 

board may require may vary depending 

on factors such as: (i) The scope and 

nature of the soft dollar program; (ii) the 

level of clarity and utility of the 

materials provided; (iii) the board’s 

confidence in the adviser’s relevant 

policies and procedures; and (iv) the 

adviser’s compliance record. For 

example, information directors seek 

may range from simple reports on the 

cost of third-party soft dollar services to 

detailed reports on all fund portfolio 

securities transactions, including 

transaction volumes, soft dollar credits, 

services provided, and broker reviews. 

To assist fund boards in carrying out 

their responsibilities under section 

15(c), we believe it is appropriate for 

fund boards to request certain 

information regarding the adviser’s use 

of fund brokerage, including soft dollar 

arrangements. Specifically, fund 

directors should require investment 

advisers, at a minimum, to provide them 

with information regarding the adviser’s 

brokerage policies, and how a fund’s 

brokerage commissions, and, in 

particular, the adviser’s use of soft 

dollar commissions, were allocated, at 

least on an annual basis. Fund directors, 

in turn, should consider this 

information when they evaluate the 

terms of the advisory contract for the 

fund. Fund directors should, for 

example, consider whether the adviser 

properly accounts for use of fund 

brokerage commissions to purchase 


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89We have considered enhancing soft dollar 

disclosure requirements in the past. For example, 

the Commission proposed a rule in 1995 that would 

have required an adviser to provide its clients with 

an annual report setting forth certain information 

about the adviser’s use of client brokerage and the 

soft dollar services received by the adviser. The 

report would have included certain quantitative 

information about brokerage allocation and 

commissions paid. See Disclosure by Investment 

Advisers Regarding Soft Dollar Practices, 

Investment Advisers Act Release No. 1469 (Feb. 14, 

1995) [60 FR 9750 (Feb. 21, 1995)]. 

90See 1998 Staff Report. 

91 Id. 

92See Amendments to Form ADV, Investment 

Advisers Act Release No. 2711 (March 3, 2008) [73 

FR 13958 (March 14, 2008)]. As proposed, Item 12 

of Part 2 would require an adviser that receives soft 

dollar products and services to disclose its practices 

and to discuss the conflicts of interest they create. 

Specifically, Part 2 would require an adviser to 

disclose to clients: (i) That it receives a benefit 

because it does not have to produce or pay for the 

products and services; (ii) that it has an incentive 

to select broker-dealers based on its interests 

instead of clients’ interests in receiving best 

execution; (iii) whether or not it pays-up for soft 

dollar benefits; (iv) whether soft dollar benefits are 

used to service all of its accounts or just the 

accounts that paid for the benefits; and (v) the 

products and services it receives, describing them 

with enough specificity for clients to understand 

and evaluate possible conflicts of interest. 

93 Id. 

research that primarily or solely benefits 

another client of the adviser. We 

specifically ask for comment on the 

information that boards should request 

and that the adviser should provide in 

connection with the board’s review of 

the advisory contract under section 

15(c). 

IV. Disclosure to Other Advisory 

Clients and Fund Investors 

Our proposed guidance is designed to 

provide fund directors with information 

that will help them fulfill their oversight 

obligations with respect to the trading 

practices of the fund’s investment 

adviser, including the adviser’s use of 

soft dollars. The fact that the guidance 

is focused on fund boards should not be 

interpreted as an indication that the 

current level of soft dollar disclosure 

that is provided to other advisory clients 

and fund investors cannot be 

improved.89 Accordingly, we solicit 

comment on whether we should 

propose additional disclosure 

requirements. 

Currently, Part II of Form ADV, the 

adviser’s firm brochure, must address 

the adviser’s soft dollar practices. 

However, a 1998 report from our Office 

of Compliance Inspections and 

Examinations (‘‘OCIE’’) observed that 

advisers’ disclosure often failed to 

provide sufficient information for 

clients or prospective clients to 

understand the advisers’ soft dollar 

practices and the conflicts those 

practices present.90 In its report, OCIE 

stated that most advisers’ descriptions 

of soft dollar practices were boilerplate, 

and urged that we consider amending 

Form ADV to require better 

disclosure.91 We sought to address this 

concern in our proposed amendments to 

Part 2 of Form ADV.92 As currently 

proposed, Form ADV would require 

advisers to discuss the conflicts of 

interest inherent in an adviser’s soft 

dollar practices and to describe the 

products and services acquired with soft 

dollars with enough specificity to 

permit clients to evaluate the conflicts 

of interest involved.93

The guidance we are proposing today 

reflects the Commission’s view of the 

critical role fund boards play in 

managing the adviser’s conflicts of 

interest. We request general comment 

on our proposed guidance. In addition, 

we specifically request comment on 

whether: (i) Further disclosure to fund 

investors of the information we suggest 

fund boards should consider would be 

helpful; (ii) any specific disclosure 

should be mandated to better assist 

investors in making informed 

investment decisions; and (iii) the 

public dissemination of particular 

information regarding a fund adviser’s 

portfolio trading practices would have 

an adverse impact on the fund adviser’s 

relationships with the broker-dealers 

that execute fund portfolio transactions. 

We also request comment on whether 

we should again consider proposing to 

require investment advisers to provide 

their clients with customized 

information about how their individual 

brokerage is being used. If so, what 

types of information would be useful 

and in what detail? Should the 

information provided be different for 

institutional and non-institutional 

clients? Do institutional clients already 

require their advisers to provide 

information to them about soft dollars 

on a regular basis, and if so, what kind 

of information do they receive? What 

are the cost implications of requiring 

individual client reports? 

V. Solicitation of Additional Comments 

In addition to the areas for comment 

identified above, we are interested in 

any other issues that commenters may 

wish to address relating to fund board 

oversight of advisers’ portfolio trading 

practices. Please be as specific as 

possible in your discussion and analysis 

of any additional issues. 

By the Commission. 

Dated: July 30, 2008. 

Florence E. Harmon, 

Acting Secretary. 

[FR Doc. E8–18035 Filed 8–5–08; 8:45 am] 

BILLING CODE 8010–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–102822–08] 

RIN 1545–BH54 

Section 108 Reduction of Tax 

Attributes for S Corporations 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking 

and notice of public hearing. 

SUMMARY: This document contains 

proposed regulations that provide 

guidance on the manner in which an S 

corporation reduces its tax attributes 

under section 108(b) for taxable years in 

which the S corporation has discharge 

of indebtedness income that is excluded 

from gross income under section 108(a). 

In particular, the regulations address 

situations in which the aggregate 

amount of the shareholders’ disallowed 

section 1366(d) losses and deductions 

that are treated as a net operating loss 

tax attribute of the S corporation 

exceeds the amount of the S 

corporation’s excluded discharge of 

indebtedness income. The proposed 

regulations will affect S corporations 

and their shareholders. This document 

also provides notice of a public hearing 

on these proposed regulations. 

DATES: Written and electronic comments 

must be received by November 4, 2008. 

Outlines of topics to be discussed at the 

public hearing scheduled for December 

8, 2008, must be received by November 

4, 2008. 

ADDRESSES: Send submissions to 

CC:PA:LPD:PR (REG–102822–08), Room 

5203, Internal Revenue Service, PO Box 

7604, Ben Franklin Station, Washington, 

DC 20044. Submissions may be handdelivered Monday through Friday 

between the hours of 8 a.m. and 4 p.m. 

to CC:PA:LPD:PR (REG–102822–08), 

Courier’s Desk, Internal Revenue 

Service, 1111 Constitution Avenue, 

NW., Washington, DC, or sent 

electronically via the Federal 

eRulemaking Portal at 

www.regulations.gov/ (IRS REG–

102822–08). The public hearing will be 

held in the IRS Auditorium, Internal 

Revenue Building, 1111 Constitution 

Avenue, NW., Washington, DC. 


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