SEC proposes guidelines for directors overseeing mutual fund portfolio trading.(Securities and Exchange Commission)

Abstract

Purpose--This paper aims to provide an update on the mutual fund industry about new brokerage review responsibilities for directors of mutual funds.

Design/methodology/approach--The paper carefully reviews the SEC release proposing the Guidelines, including the appendices to the Release. The appendices set forth numerous questions that directors should ask when reviewing mutual fund brokerage and soft dollar arrangements. Advisers and brokers need to take immediate steps so that they are in a position to fully answer these questions.

Findings--As noted in the paper, the release is noteworthy because the SEC guidelines, if adopted, will require directors to probe mutual fund advisers for a remarkable amount of detail about brokerage and soft dollar arrangements. In some cases, the new responsibilities will bring directors close to managing certain aspects of these arrangements.

Practical Implications--It is clear that brokerage practices are a top priority of the SEC and that agency is now expecting far more involvement by directors in the process of placing trades for mutual funds and obtaining research through soft dollars.

Originality/value--The paper may serve as a road map for advisers when reviewing their brokerage compliance procedures and attorneys and consultants to mutual fund boards when setting agendas for board meetings.

Keywords United States of America, Investments, Compensation, Regulation

Paper type Technical paper

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On July 31, 2008, the US Securities and Exchange Commission (SEC) published proposed guidelines for mutual fund directors overseeing the portfolio trading practices of an investment adviser to a mutual fund [1]. The Guidelines address the board of directors' review of the best execution obligations of the mutual fund's investment adviser and soft dollar arrangements. In the proposing release ("Release 58264" or the "Release"), the SEC also discussed how directors should consider brokerage and soft dollars in their annual "15(c) review" of investment advisory contracts. In addition, the SEC requested comments on whether to propose a new disclosure document for investment advisers addressing the use of client brokerage arrangements.

Purpose of the guidelines

Release 58264 begins with a discussion about brokerage costs and the SEC's concern for fund shareholders since brokerage can be a substantial cost for many funds. The Release then reviews conflicts of interest that may arise in brokerage practices and soft dollar arrangements. With respect to brokerage, a conflict of interest between the investment adviser and mutual fund may arise:

* when an adviser executes trades through an affiliate;

* when an adviser determines the allocation of trades among its clients;

* when an adviser trades securities between clients;

* when an adviser uses fund brokerage commissions to pay for research and brokerage services, which may give the adviser the incentive to disregard its best execution obligation; and

* when an adviser trades the fund's securities in order to earn credits for fund brokerage commission services.

In the SEC's …