CSA 92/01 - Soft Dollar Transactions [CSA Notice - Rescinded]

Introduction

As a result of recent submissions, the Canadian Securities Administrators (the "CSA") have concluded that certain concerns in connection with "soft dollar" or "soft commission" transactions should be investigated to determine whether changes to the existing regulatory regime relating to these transactions are necessary or whether an alternative regulatory response is required. Consequently, the CSA are issuing this Request for Comments.

By way of background, in 1986, the Ontario Securities Commission (the "OSC") and the Commission des valeurs mobilières du Québec (the CVMQ) adopted OSC Policy Statement No. 1.9 ("OSC Policy 1.9") and CVMQ Policy Statement No. Q-20, respectively (collectively, the "Soft Dollar Policies"). Although these policies were discussed by the CSA at the time they were adopted, a National Policy Statement on soft dollar transactions was never formally adopted. If, following an analysis of the responses to their Request for Comments, the CSA consider it advisable to adopt a National Policy Statement, such a policy could adopt the approach taken in the Soft Dollar Policies (which staff of the OSC and the CVMQ believe have proved effective within their scope), with such amendments as the CSA consider necessary to address current concerns.

The CSA consider soft dollar or soft commission transactions as being those which involve the payment by a portfolio/fund manager or adviser to a dealer of commissions in circumstances where a percentage of the commissions are used by the dealer to fund or pay for goods and services. These goods and services may be provided by the dealer or by third parties to the manager, the adviser, the sponsor or the portfolio/fund beneficiaries. As well, soft commissions may take the form of reciprocal commissions, which are discussed in further detail below.

Background

Soft dollar transactions may arise in a variety of circumstances. The conventional situation is where commissions are paid by a portfolio manager to a dealer in return for investment decision-making and order execution services which are provided by the dealer to the manager.

One use of soft dollars which has been a cause for concern to some capital market participants involves the triangular relationship established when a fund or pension plan sponsor requires the fund or pension plan manager to direct brokerage transactions to a particular dealer. That dealer in turn is required to use a portion of the commission income from the brokerage transaction to fund the provision to the sponsor of goods and/or services. One example of this practice is the payment by a dealer out of commission revenues to a third party performance measurement firm of amounts in return for the provision of reports and information directly to the sponsor. Another example of the use of soft dollars is where a "reciprocal commission" is paid, i.e. where execution business providing a brokerage commission is directed by a mutual fund manager or adviser to a dealer as compensation for sales of the mutual fund's units. A further example is where soft commissions are used to fund other non-conventional services, such as dealer advertising with respect to a particular mutual fund.

Each of the Soft Dollar Policies states that the negotiation of commissions is governed by the general obligation of the manager to act in the best interests of the beneficiaries of the portfolio or fund and that, consequently, commissions must only be used as payment for goods and services which are for the benefit of the beneficiaries, and should not be used as payment for goods and services which are for the benefit of the manager.

The Soft Dollar Policies recognize the utility to beneficiaries of "investment decision-making" and "order execution" services (both of which phrases are broadly defined) provided to the manager, and state that such services may legitimately be provided in return for soft dollars. In respect of other goods and services, the Director of the OSC, in a notice published in November 1987, which dealt specifically with the question of whether it was appropriate for shareholder litigation to be funded through soft dollars, stated that the Director (now the Executive Director) will exempt similar soft dollar transactions on a case-by-case basis where benefits are clearly intended to accrue to shareholders, as opposed to solely the manager or the plaintiff, and all commissions on the directed trades are at competitive levels.

With respect to reciprocal commissions in the mutual fund context, the Soft Dollar Policies provide that these are permissible if the commission rates charged are equivalent to those which would have been normally charged by the dealer if the dealer did not distribute units of the mutual fund and if certain disclosure requirements are met.

During the six years since the adoption of OSC Policy 1.9, staff of the OSC have received very few requests for relief or exemption from the provisions of that policy. While staff of the OSC believe that OSC Policy 1.9 has proved effective within its scope, they recognize that there may be instances of abuse which may not have been adequately provided for in that policy. The experience of CVMQ staff is comparable. Accordingly, the CSA are issuing this Request for Comments.

Request For Comments

The responses provided in connection with this Request for Comments will supply the information necessary for a comprehensive analysis of whether and to what extent changes should be made to the Soft Dollar Policies (whether in connection with the adoption of a National Policy Statement or otherwise) or compliance actions should be implemented or increased. Comments are sought with respect to the implications, both positive and negative, of soft dollar arrangements for the health of the capital markets generally. In this regard, dealers, fund and portfolio managers and advisers, investors and other interested persons are asked to provide a description of soft dollar arrangements in the marketplace of which they are aware, with particulars relating to all aspects of these arrangements. The business of the parties involved, the benefits which accrue to them and the relationship between them are of particular interest. It will be helpful if the responses provide specific details with respect to the volume and dollar value of soft dollar transactions engaged in, together with a breakdown of the types of goods and services for which payment is being made through soft dollars. In addition, comments are sought in respect of the conflict of interest implications of soft dollar arrangements.

In connection with the use of reciprocal commissions in the mutual fund industry, in August 1991, The Investment Funds Institute for Canada ("IFIC") issued its report on mutual fund sales incentives. The code of conduct (the "IFIC Code") for IFIC members which resulted from that report prohibited the direction of brokerage commissions to a dealer as compensation for anything other than investment decision-making services or order execution services (as defined in OSC Policy 1.9). In November 1991, the CSA published a notice which stated, among other things, that the CSA had noted the recommendations in the report with respect to reciprocal commissions and that they intended to consider these recommendations further. The CSA also stated that, pending discussion, they expected that the mutual fund industry would follow the IFIC Code.

Following the publication of the IFIC Code, there has been considerable debate with respect to the advisability of reciprocal commissions. As a result, and as part of this initiative, the CSA are requesting specific submissions relating to the public interest and other implications (including the potential benefits to unitholders and the impact on the competitive position of particular segments of the mutual fund industry) of reciprocal commission arrangements made to compensate dealers and their sales staff for mutual fund sales, advertising expenses incurred to promote mutual fund sales and other marketing related matters.

The CSA understand that persons submitting responses may be concerned from a confidentiality perspective as a result of competitive, commercial or economic considerations. Accordingly, responses will, upon request, be treated as confidential and will not be placed on the public files of the securities regulatory authorities. Public access to such responses will not be permitted except as may be required by law. However, copies of all responses will be circulated among and reviewed and considered by the CSA in connection with this initiative.

Comments should be in writing only, and twelve copies of each comment letter should be delivered to the attention of the CSA. Comments relating to reciprocal commissions in connection with mutual funds should be submitted no later than July 31, 1992, and all other comments should be submitted on or before September 25, 1992. All comment letters should be delivered to the following address:

Canadian Securities Administrators
c/o Secretary, Ontario Securities Commission
8th Floor
20 Queen Street West
Toronto, Ontario
M5H 3S8