Wednesday, July 19, 2006

Congressional Inaction on Soft Dollars Heightens Importance of SEC Guidance

The SEC has issued an interpretive release on the use of soft dollars, which promises to be seminal. SEC Chairman Christopher Cox has described soft dollars as an anachronism. Others have been even tougher. In a recent Wall Street Journal op-ed piece, Benn Steil, director of international economics at the Council of Foreign Relations, criticized soft dollars as a kickback scheme and called on Congress to abolish the practice. But in my view Congress will not repeal Section 28(e) of the Exchange Act. Historically, Congress has shown little enthusiasm for one statute ``fixes’’ of the federal securities laws, which means that any change in this area would have to come as part of broad market reform legislation, which is highly unlikely to occur. If I may be permitted a strained analogy, Congress is as reluctant to legislate one statute ``fixes’’ of the securities laws as it is to legislatively overrule one US Supreme Court opinion. But congressional inaction heightens the importance of the SEC’s interpretation.

The Commission cautions that eligible research services are limited to advice, analyses, and reports under the statute. This means that traditional research reports and market data satisfying the eligibility criteria of Section 28(e) are eligible for the safe harbor as research, but that computer hardware is not. The release also indicates that mass-marketed publications are not eligible under the safe harbor. Chairman Christopher Cox explained that the purpose of the release is to better circumscribe the use of soft dollars, which he described as essentially inflated brokerage commissions, to ensure that they are used only for research.

According to the Commission, the statutory analysis of brokerage and research requires a three-step process: the application of eligibility criteria; the money manager's lawful and appropriate use of the items; and the money manager's good-faith determination that the commissions paid are reasonable in light of the value of the services received.