Disclosure is at the heart of a number of currently proposed regulatory initiatives. You will find few — if any — who will argue with better disclosure if there is a meaningful benefit to the end user, the investor.

But will the investor actually benefit from new proposed requirements outlined in the latest version of NI 23-102 (Use of Client Brokerage Commissions as Payment for Order Execution Services or Research Services), more commonly known as soft dollars?

In most jurisdictions, soft dollars has no legal definition. However, it is generally considered to be the practice of dealers using commissions on brokerage transactions for managed accounts to pay for goods or services given to the manager of the account. So basically, if your company uses ABC dealer to execute an order for its client and, using part of the commission paid by the client, ABC dealer also provides the company with “free” research — and the company uses that research — then that research is considered to be “soft dollars”.

The latest proposed instrument does show improvements from a previous proposal. The Investment Funds Institute of Canada, along with other members of the financial services industry, had requested that any new requirements be consistent with those in larger jurisdictions, such as the U.S. As Canada is a small market, making rules and regulations substantially different here could potentially shut out our market from accessing U.S. sub-advisors.

The Canadian Securities Administrators, in its latest proposal for these regulations, responded positively to many of the requests for changes. IFIC believes significant strides have been made towards consistency with equivalent U.S. requirements regarding soft dollars used to pay for research — but not when it comes to order execution services. The SEC has allowed some services, dealing with connectivity and hardware, but the CSA views these as overhead costs and believes it is difficult for the manager to justify paying for those services with client brokerage commissions. As well, such distinctions often become more difficult to apply as new products evolve. There is no obligation on U.S. firms to disclose their practices; they can choose not to do business with Canadian managers who attempt to impose Canadian requirements on them.

Also, there are some practical implementation issues that need to be worked out. Currently, NI 81-106 (Continuous Disclosure) sets out that notes to financial statements disclose total commissions and other transaction costs paid to dealers. That’s in addition to separate disclosure of soft-dollar payments if the soft dollar portion is used to pay for goods and services other than for executing an order. On top of that, it requires that disclosure of a fund’s use of commission dollars be included in the management report of fund performance. Both the interim financial statements and the MRFP are already available to investors semi-annually and on the Internet. There also are existing requirements relating to soft dollar disclosure in a fund’s annual information form.

Regulators are now asking for further disclosure, including the total of client brokerage commissions paid, as well as the advisor’s “reasonable estimate” of how much of those commissions represent soft dollars. We believe this is a subjective test that makes meaningful comparison among different funds virtually impossible.

But what about the investor? Are there any real abuses? An International Organization of Securities Commissions survey of regulators around the world found no abuses. Will new disclosure methods make it any more meaningful? The B.C. Securities Commission is considering whether the existing duty for managers to act fairly, honestly and in good faith, together with guidance and the use of other regulatory tools including compliance reviews and education, may be the most appropriate way to regulate client brokerage commission arrangements.

The CSA has already said it will consider further amendments to harmonize requirements in NI 23-102 with those ultimately put in place in the U.S. We urge the CSA to work with the industry to find the appropriate disclosure. IE



Joanne De Laurentiis is president and CEO of the Investment Funds Institute of Canada.