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Soft Dollar Safe Harbor

April 2002

The Securities and Exchange Commission recently modified its interpretation of the Section 28(e) safe harbor to permit riskless principal transactions in Nasdaq-traded securities to generate soft dollar credits.

Safe Harbor Section 28(e) of the Securities Exchange Act of 1934 provides a safe harbor to investment advisers who use the commission dollars of their advised accounts to obtain research and brokerage services. To rely on the safe harbor, an adviser must determine that the amount of the commission is reasonable in relation to the value of the research and brokerage services received.

Riskless Principal Transactions in Nasdaq-traded Securities The SEC previously interpreted Section 28(e) to be available only for transactions effected in an agency capacity, in part because the fees on agency transactions were more transparent than on principal transactions. The Nasdaq Stock Market, Inc. asked the SEC to reconsider this interpretation. Since the time of the original interpretation, the NASD has modified its trade reporting rules for riskless principal transactions. An eligible “riskless principal transaction” is a transaction in which a broker-dealer, after having received an order to buy a security, purchases the security as principal at the same price to satisfy the order to buy or, after having received an order to sell, sells the security as principal at the same price to satisfy the order to sell. The NASD trade reporting rules require a riskless principal transaction in which both legs are executed at the same price to be reported once, in the same manner as an agency transaction, exclusive of any markup, markdown, commission equivalent, or other fee. The confirmation will disclose this price and the compensation to the NASD member for effecting this transaction. Thus, an adviser opting for a riskless principal transaction in a Nasdaq-traded stock would now have the necessary information to determine whether the transaction fee was reasonable in relation to the value of the research and brokerage services received.

What's Not Covered The SEC noted that the interpretation does not currently apply to traditional riskless principal transactions in the debt market and traditional principal transactions involving a dealer’s inventory. Fees on other riskless principal transactions can include an undisclosed fee (reflecting a dealer’s profit on the difference in price between the first and second legs of the transaction). Fees on traditional principal transactions can also include an undisclosed fee based on some portion of the spread. The SEC also noted that the interpretation does not extend to other securities that may have similar reporting requirements, but that do not have the same confirmation requirements, such as OTC Bulletin Board stocks, Pink Sheet stocks, and convertible securities.

This newsletter is published to provide our friends and clients with current information that may affect their businesses. This information is not intended to serve as specific legal advice or as a solicitation for business. If you have any questions about Section 28(e), please contact any member of our Investment Management Group.

Media Contact 

If you have a media request or need an attorney with particular knowledge for comment, please contact Susan Steberl, Director of Marketing, at 414.287.9556 or ssteberl@gklaw.com.

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