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Canada Issues New Soft-Dollar Guidance

Canadian regulators have issued new soft-dollar commission disclosure requirements, which, if adopted, would be less ambitious than those originally proposed in July 2006, but stricter than the Securities and Exchange Commission’s.

Reflecting market concerns, the soft-dollar measures, out for comment until April 10, place greater emphasis on narrative disclosure while significantly reducing the amount of quantitative disclosure.

“Due to the lack of precision regarding costs for bundled services, as well as timing differences between the trades that generate the commissions and the payment with those commissions for the goods and services, we agree that the detailed disclosure would be difficult to make with any degree of accuracy,” said the Canadian Securities Administrators (CSA), an umbrella organization for the securities regulators of the country’s 13 provinces and territories.

An estimated 60 percent of Canadian investment advisers buy third-party research through soft-dollar arrangements--a practice whereby money managers’ brokerage commissions cover other costs.

Regulators in Ontario and Quebec adopted guidelines for soft-dollar commissions in 1986, but they only apply to those provinces. The U.K.’s Financial Services Authority (FSA) adopted its final rules on soft-dollar commissions in July 2005, and the SEC placed limits on soft dollars in July 2006.

The CSA has proposed that fund advisers describe the “process for and factors considered in selecting dealers to effect securities transactions; the procedures for ensuring that over time clients receive reasonable benefit from usage of the brokerage commissions charged to them; and the methods by which the determination of the overall reasonableness of client brokerage commissions paid in relation to order execution services and research services received is made.”

Fund advisers, said the CSA, must disclose the “total client brokerage commissions paid by the client during the period reported on”--reporting would be at least annual. Advisers must also estimate on an aggregate basis, across all clients, or a particular group of clients, the portion of commissions paid for goods and services.

The CSA initially wanted to go beyond the FSA’s requirements by mandating client-level and security-level disclosure of the commission amounts. But respondents to the requests for proposal in 2006 argued that the rules would be too cumbersome and costly to follow. They also said that Canada should harmonize its practices with the U.S rather than the U.K.

“The reality is that it would be very difficult for Canada to diverge too far from U.S. practices,” which do not require commission disclosure, said Integrity Research, a Darien, Conn. consulting firm that rates equity research, on its blog. “As it is, the CSA is diverging from the U.S. in technical elements such as the temporal standard or specific items which are eligible.”

In the new proposal, the CSA expanded its definition of research to allow for seminars, trade journals and expert networks, provided the services are used in the investment decisionmaking process and benefit clients.

The regulator also clarified its “temporal standard,” saying that order execution includes “goods and services directly related to the execution process that would be provided or used between the point at which an adviser makes an investment decision and the point at which the resulting securities transaction is concluded.” By removing the word “trading” from the definition, the CSA has changed the types of services that fall under order execution and those that will be classified as research services.

The use of raw market data, for example, will now be considered a research service, which is how the SEC views it; the FSA calls it order execution.

Post-trade analytics, formerly classified as research, could now be order execution, to the extent that it is used to determine how, when and where to place a trade. Order management, pre-trade analytics and algorithmic trading software could fall under order execution.

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