Monday, June 19, 2006

Fiduciaries own "Soft Dollars"

Benn Steil comments on the pending interpretative release by the SEC on brokerage soft dollar practices in todays WSJ. Of significance to pension plan fiduciaries is the fact that “if the fund manager buys items directly from the suppliers, he pays with his firm's cash. If he buys them through brokers when executing trades, however, the law, or the SEC, lets him use his clients' cash.”

From an ERISA perspective, payments for commissions are Plan assets and must be used to directly benefit plan participants. Steil, in previous testimony to the US Senate estimated that the average institutional broker kicks back $1 for each $1.60 it receives in commissions. This $1 kickback is legal under the Section 28e “safe harbor” of the 34 Act. Section 28e allows an investment adviser to pay “more” than the lowest available commission rate to a broker, and still fulfill his fiduciary duty. The SEC merely requires that advisors subjectively determine if the paying of a higher commission provides better value to its customers. Better value doesn’t always correlate to participant benefit. Steil notes that “client-financed commission payments have become so generous that a broker for one of the nation's largest fund management companies made the headlines in 2003 by thanking the funds' traders with a lavish dwarf-chucking bachelor party”.

Despite the fact that plan fiduciaries may delegate discretionary authority and thus fiduciary status to their money managers, they retain the responsibility to monitor the manager’s use of plan assets. Plan fiduciaries should document and review their providers soft dollar policies and practices.

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