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. INVESTMENT ADVISER ASSOCIATION INVESTMENT ADVISER ASSOCIATION SOFT DOLLARS WEBINAR June 3, 2010 Soft Dollar Arrangements: Commission Sharing vs. Traditional Soft Dollar Sh i T diti l S ft D ll Arrangements & Other Current Issues

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INVESTMENT ADVISER ASSOCIATION INVESTMENT ADVISER ASSOCIATION SOFT DOLLARS WEBINAR

June 3, 2010

Soft Dollar Arrangements: Commission Sh i T diti l S ft D ll Sharing vs. Traditional Soft Dollar Arrangements & Other Current Issues

Steven W. Stone Morgan, Lewis & Bockius LLP Monique S. Botkin Investment Adviser Association

www.morganlewis.com

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Critical Elements of Commission Sharing A t & S ft D ll Arrangements & Soft Dollars

  • Key Concepts
  • “Research” &

“B k ”

  • Different Structures
  • Traditional

“Brokerage”

  • “Good Faith

Determination”

  • Third-Party
  • CSAs

Determination

  • “Provided by” Test

CS s

  • Current Issues
  • “Effecting”

Investment Adviser Association Soft Dollars Webinar

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Polling Question #1 Polling Question #1

  • Does your firm use client commissions to
  • btain any of the following? (check all that

apply): apply):

 Proprietary research  Third-party research  Brokerage services  Brokerage services  Other

Investment Adviser Association Soft Dollars Webinar

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SLIDE 4

Polling Question #2 Polling Question #2

  • Does your firm manage accounts investing in?

 Equities  Fixed Income  Both

Investment Adviser Association Soft Dollars Webinar

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At a Glance Research At a Glance - Research

  • Research -- Content used for investment decision-making
  • Research includes (in contrast to FSA stance)
  • Market data
  • Seminars and conferences

R h l d d t d i

  • Research excludes products and services
  • That do not reflect “the expression of reasoning or knowledge” or
  • With inherently tangible or physical attributes (e g

computer

  • With inherently tangible or physical attributes (e.g., computer

hardware & accessories)

Investment Adviser Association Soft Dollars Webinar

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SLIDE 6

Examples of Research Examples of Research

R h

N t R h

  • Research
  • Traditional research reports

analyzing performance of a

  • Not Research
  • Products that don’t reflect

“expression of reasoning or knowledge”

y g p company or stock

  • Financial newsletters and

trade journals

g

  • Products with tangible or physical

attributes

  • Computer hardware & Accessories

trade journals

  • Quantitative analytical

software and software that

  • Office furniture, travel expenses &

entertainment

  • Meals associated with attending

seminars W b it d i il ft &

analyzes securities portfolios

  • Seminars & conferences
  • Website design, email software &

Internet service

  • Legal expenses & Membership dues
  • Proxy voting services

Investment Adviser Association Soft Dollars Webinar

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Seminars & conferences

  • Except as used for investment

decisions

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SLIDE 7

Polling Question #3 Polling Question #3

  • Does your firm share research with any

affiliates?

 Yes  No  Not applicable (e.g., we do not have any

affiliates)

Investment Adviser Association Soft Dollars Webinar

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SLIDE 8

Polling Question #4 Polling Question #4

  • Does your firm pay brokers for their proprietary

research with hard dollars?

 Yes  No

Investment Adviser Association Soft Dollars Webinar

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SLIDE 9

At a Glance - Brokerage At a Glance Brokerage

P d t d i th t

  • Products and services that
  • Relate to the execution of a trade
  • From when a money manager transmits an order through settlement

y g g

  • Brokerage services
  • Order routing software and algo trading software
  • Exchange of messages among brokers, custodians, and institutions
  • Electronic communication of orders, allocation instructions
  • Routing settlement instructions to custodians and clearing agents
  • Routing settlement instructions to custodians and clearing agents
  • OMSs, based on functional analysis
  • Post-trade matching

Investment Adviser Association Soft Dollars Webinar

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Post trade matching

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Communications Services Communications Services

C i ti i

  • Information delivery

mechanisms are not research

  • Communications services

for execution, clearing, or settlement of trades can

research

  • Because they do not

reflect substantive be brokerage

  • Dedicated lines between a broker and

a money manager’s OMS

reflect substantive content related to investment decisions

  • Lines between a broker and OMSs
  • perated by a third-party vendor
  • Dedicated lines providing direct dial-up

service between a money manager and

  • E.g., telecom lines &

computer cables

service between a money manager and a broker’s trading desk

  • Message services used to transmit
  • rders to brokers for execution

Investment Adviser Association Soft Dollars Webinar

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Good Faith Determination Good Faith Determination

  • Money managers bear the burden in making a “good faith

determination” that the amount of commissions paid is reasonable in relation to the value of brokerage & research services received

  • “Mixed Use” Products
  • Mixed Use Products

Investment Adviser Association Soft Dollars Webinar

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“Provided By” Requirement Provided By Requirement

1 P idi i t h 1. Providing proprietary research 2. Paying for 3d-party research where broker is financially responsible 3. Paying for 3d-party research for which money manager is financially responsible where broker

  • Pays the research vendor directly

R i th d i ti f th h f “ d fl ” th t th

  • Reviews the description of the research for “red flags” that the

research is not within the safe harbor and reaches agreement with the money manager that it will use client commissions only to pay for items that reasonably fall in the safe harbor to pay for items that reasonably fall in the safe harbor

  • Develops and maintains procedures so that research payments

are documented and paid for promptly

Investment Adviser Association Soft Dollars Webinar

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“Effecting” Test Effecting Test

E ti l i ttli t d

  • Executing, clearing or settling trades
  • Directly
  • Clearing arrangements

g g

  • Step-outs and prime brokerage transactions
  • Limited other functions – (any one, where others done by another broker)
  • Taking financial responsibility for trades until the clearing broker has

received payment or securities

  • Making or maintaining records on trades per SEC and SRO rules,

including blotters and order memoranda

  • Monitoring and responding to customer comments on the trading

process

Investment Adviser Association Soft Dollars Webinar

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  • Generally monitoring trades and settlements

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Polling Question #5 Polling Question #5

  • Has your firm’s use of soft dollar arrangements

increased over the past year?

 Yes  No

Investment Adviser Association Soft Dollars Webinar

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Polling Question #6 Polling Question #6

  • Does your firm have any commission sharing

arrangements?

Yes No

Investment Adviser Association Soft Dollars Webinar

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“Classic” (1975) Classic (1975)

Trades

Manager Broker Manager Broker

Research

Investment Adviser Association Soft Dollars Webinar

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Third-Party Arrangement (1986) Third Party Arrangement (1986)

Manager Executing Research Executing Broker Research Provider

Investment Adviser Association Soft Dollars Webinar

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“Hard Dollar” (2004) Hard Dollar (2004)

$Money$

Manager Broker Manager Broker

Research

Investment Adviser Association Soft Dollars Webinar

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Commission Sharing Arrangement (2006) Commission Sharing Arrangement (2006)

Manager Executing Research P id Broker Provider Non- Executing Broker

Investment Adviser Association Soft Dollars Webinar

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SLIDE 20

Commission Aggregation Arrangement (2009) (2009)

Manager Commission Aggregator Commission Aggregator Executing Executing Broker Executing Broker Research Provider Investment Adviser Association Soft Dollars Webinar

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Emerging Focus on Best Practices Emerging Focus on Best Practices

January

November 1997 – SIA Best Practices for Firms that Engage in Soft D ll & Oth

March 1998 – ICI B k January 2007 – Revised SEC Interpre- tation

Dollar & Other Commission Arrangements

Brokerage Allocation Practices tation Takes Effect

September 1998 – SEC Staff, I ti

June 1998 – AIMR Soft Dollar July 2008 – SEC, Proposed Guidance on

Inspection Report on the Soft Dollar Practices of Brokers, Investment Advisers and

Soft Dollar Standards: Guidance for Ethical Practices Involving Guidance on the Duties and Responsibilities

  • f Investment

Company Boards of

Investment Adviser Association Soft Dollars Webinar

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Advisers and Mutual Funds

Client Brokerage Directors

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Focus on Mutual Fund Boards (2008) Focus on Mutual Fund Boards (2008)

  • Proposed 2008 Guidance would task mutual fund boards
  • Proposed 2008 Guidance would task mutual fund boards

with asking:

  • How the adviser identifies the amount and types of

research obtained research obtained

  • How soft dollar budgets are established and how

brokerage allocations are made

  • How the adviser determines its use of soft dollars is within

the safe harbor

  • How soft dollar products and services are allocated among
  • How soft dollar products and services are allocated among

clients

  • How mixed-use products are evaluated

Investment Adviser Association Soft Dollars Webinar

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Current Issues Current Issues

  • Client “no soft” or “no

third-party” bars & “free riding” issues

  • Converting soft dollar

balances to client rebates free riding issues

  • Tax issues

Portability of soft rebates

  • Sharing research with

affiliates

  • Portability of soft

dollar balances

  • Use of aggregators

affiliates

  • Cross border trading
  • ERISA service
  • Use of aggregators
  • Protecting soft dollar

balances

  • ERISA service

provider compensation

Investment Adviser Association Soft Dollars Webinar

balances compensation disclosure

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.

INVESTMENT ADVISER ASSOCIATION INVESTMENT ADVISER ASSOCIATION SOFT DOLLARS WEBINAR

Soft Dollar Arrangements: Commission Sh i T diti l S ft D ll

June 3, 2010

Sharing vs. Traditional Soft Dollar Arrangements & Other Current Issues

Monique S. Botkin Investment Adviser Association Steven W. Stone Morgan, Lewis & Bockius LLP

www.morganlewis.com