ADOPTING RELEASE OF THE AIMR TRADE MANAGEMENT GUIDELINES SUMMARY In 1999, the AIMR Board of Governors created the Best Execution Task Force to further the review of “best practices” related to Best Execution 1 (introduced in the AIMR Soft Dollar Standards). On 12 November 2001, the Association for Investment Management and Research® (AIMR®) released for public comment its proposed Trade Management Guidelines (TMG). A product of the AIMR Trade Management Task Force, the TMG recommend practices that will help investment management firms fulfill their fiduciary duty to clients to seek Best Execution and provide a systematic, demonstrable approach to trade management. In response to industry comments received during the ensuing 90-day comment period, the Task Force revised the proposed TMG for submission to the AIMR Board of Governors. Provided below is a summary of the TMG, as adopted, as well as a discussion of the treatment of comments received during the public comment period.

ADDITIONAL INFORMATION An electronic copy of the TMG is available by visiting AIMR’s Web site at http://www.aimr.org/standards/ethics/. Alternatively, to request a paper copy you may contact AIMR’s Professional Standards and Advocacy Department via facsimile at 1-434-951-5320; via e-mail at [email protected]; or via post at 560 Ray C. Hunt Drive, P.O. Box 3668, Charlottesville, VA 22903-3668.

HIGHLIGHTS OF THE ADOPTED RECOMMENDATIONS The TMG focus on the fiduciary duty of Firms to seek to achieve Best Execution for client trades. The TMG formalize processes, disclosures, and record keeping recommendations that together form a systematic, repeatable, and demonstrable approach to seeking Best Execution. Although specifically intended for Firms, the TMG will afford all investment professionals and their clients a better understanding of the complexities of seeking Best Execution. 1. Processes The TMG contain recommendations that encourage Firms to establish written policies and procedures that have the ultimate goal of maximizing the asset value of client portfolios through Best Execution taking into account each client’s investment objectives and constraints. These policies and procedures should address how employees can manage effectively the quality of trades.

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See Definitions in AIMR Trade Management Guidelines.

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2. Disclosures Disclosure recommendations are based on the strong belief that Firms should disclose to current and prospective clients their (1) general Broker selection practices and (2) any actual or potential trading related conflicts of interest. This information will help clients assess a Firm’s ability to deliver Best Execution and, thereby, maximize the value of investment actions within their individual investment objectives and constraints. 3. Record Keeping Record keeping recommendations encourage Firms to maintain proper documentation of (1) compliance with its policies and procedures and (2) the disclosures provided to clients. In addition to aiding in the determination of Best Execution, the records may help a Firm meet its regulatory record keeping requirements and support its Broker selection practices when examined by applicable regulatory organizations.

LIST OF SIGNIFICANT CHANGES The following list outlines significant changes made to the TMG in response to the comments received during the public consultation process: • • • • • •

Clarifying that the TMG are recommendations, not standards; Acknowledging the U.S. centric nature of the recommendations and committing to review and include, when appropriate, global Best Execution recommended practices in the future; Limiting the recommendation to measure the execution quality of trades to those securities with reliable comparative data that are readily available and clarifying that measurement is one among various factors that Firms should consider when evaluating Best Execution; Postponing the recommendation to adopt the AIMR Soft Dollar Standards until a pending review of such Standards is complete; Introducing a recommendation addressing Client-Directed Brokerage Agreements; and Recommending that Firms disclose the use of client brokerage to obtain goods and services that do not constitute Research or brokerage services.

SUMMARY OF COMMENTS The list below references respondents by individual name, firm, and trade organization (where applicable) coupled with their designated abbreviation used throughout this document2. Individuals: • • • 2 *

Daniel Broby (Broby) Richard Dabrowski, CFA* David Harding, CFA* Comment letters are available at http://www.aimr.org/standards/issues/tm_comments.html. Submitted four identical letters.

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• • • •

Thomas Harrison, CFA* Jeremy Hellman, (CFA) (Hellman) Gerald Lins (Lins) Thisha Schuster, CFA*

Firms: • • • • • •

AIM Management Group (AIM) Capital Guardian Trust Company (CGTC) Fidelity Management and Research Company (Fidelity) Goldman Sachs Asset Management (GS) Nicholas Applegate (NA)* T. Rowe Price (TRP)

Trade Associations: • • • •

The European Trade Forum’s Standing Committee on Transaction Cost Analysis (ETF) The Investment Company Institute (ICI) The Investment Counsel Association of America (ICAA) The Securities Investment Association (SIA)

I. U.S. SEC Existing and Future Requirements A. Respondents raised concerns over the possible overlap between the pending (1) U.S. Securities and Exchange Commission (U.S. SEC) Best Execution Report and revisions to Form ADV and (2) the TMG. The Task Force shared the respondents’ concerns over the possible overlap between the TMG and the pending U.S. SEC Best Execution Report. To avoid contradictory information, the Task Force obtained confirmation from the U.S. SEC observer to the Task Force noting that there were no philosophical differences between the TMG and the pending U.S. SEC Report. Given this reassurance and the limited regulatory and legal framework specifying the Best Execution obligations of investment advisers, the Task Force decided to move forward with the TMG. Should the U.S. SEC issue a report, AIMR will review the TMG and amend if necessary. B. Respondents cautioned AIMR against making recommendations that differed from existing U.S. SEC and other legal requirements. Although existing legal frameworks provide valuable information to the best practices setting process, the Task Force viewed the underlying purpose of the TMG as being one that provides Firms with information as to what they “should do” versus what they “must do.” In addition to proving Firms guidance on desirable trading practices, the TMG may serve as a positive example to regulatory organizations of a voluntary, industry driven form of self-regulation. The TMG also sought to provide guidance to Firms globally and

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to Firms that fall out of the purview of the Investment Advisers Act of 1940 and of the U.S. SEC. Therefore, the Task Force decided that, where appropriate, the TMG would recommend a higher practice than what currently required by U.S. law and regulatory requirements. Because the TMG do not restate regulatory and legal requirements, the Task Force found it necessary to emphasize that Firms, implementing some or all of the recommendations in the TMG, ensure compliance to all applicable local laws and regulations. II. Rules 11 Ac 1-5 and 11c 1-6 CGTC, AIM, and the ICAA believed the U.S. SEC order routing rules and resulting reports to be of little value to Firms and questioned the futility of the paragraphs devoted to Rules 11Ac1-5 and 11c1-6. Specifically, CGTC and AIM did not find the reports helpful to institutional investors as they exclude data on block trades and the ICAA viewed the reports as being difficult to obtain and interpret. In contrast, the SIA noted that the intent behind the rules was to: (1) increase the opportunity for investors to evaluate what happened to their orders; and (2) encourage competition among market-centers and market-makers. Because of the investors’ minimal experience with the rules (given their newly-issued status) and their considerable cost to date to Brokers, the SIA advised that “AIMR refrain from recommending its own Trade Management Guidelines.” Although the reports exclude information on block trades per se, such trades are often executed in small pieces, which would most likely be reflected in the data. The noted difficulties in obtaining and understanding the content of these reports will likely become less problematic as the market place becomes better acquainted with their content. Regardless, the Task Force viewed these reports as a potential source of additional information that may help Firms evaluate the quality of trades. The Task Force added language to clarify this potential use. III. General Approach of the TMG Lins was concerned that the specificity of the TMG placed “form” over “substance,” which could hinder the Best Execution evaluation process. He preferred a more general approach to the TMG where general recommendations would be illustrated with examples of helpful practices. Along similar lines, the ETF recommended that the TMG be sufficiently generic to apply to all industry participants and suggested paring down the TMG to core competencies for now and expanding on these based on future experiences. Alternately, the ICAA asked that the TMG specify how Firms would implement the recommended procedures. In particular, the ICAA was concerned that small Firms could encounter interpretative difficulties in this regard. In developing the TMG, the Task Force carefully avoided being too general in nature (so to provide useful guidance to Firms of all sizes and financial resources) while striving to

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provide sufficient specificity that was not overly prescriptive. The Task Force viewed the divergence of the aforementioned comments as evidence that it struck the right balance. Due to the subjectivity and complexity of the subject matter at hand, the Task Force thought it best to limit the applicability of the TMG to advisory firms. The AIMR Standards of Practice Council (SPC) 3 will provide interpretations on the TMG to the industry upon request. IV. Fixed Income Securities Fidelity, Lins, and the ICAA noted that the TMG as written did not apply to fixed income and derivative trading strategies. The ICAA stated that fixed income transactions: a. b. c.

trade in smaller volumes than equity transactions and are subject to less liquidity and greater market impact; take longer to complete; and have unique issues that could require using a smaller, more expensive Broker.

Lins added that the TMG as written did not apply to pairs-trading, short-selling, and arbitrage strategies. Fidelity questioned the futility of trade quality measurement outside of equity markets given that comparative data were frequently unavailable and few accepted methodologies existed. Respondents recommended: a. limiting the applicability of the TMG to equity trades only; b. expanding the TMG to reflect special circumstances of non-equity transactions; or c. limiting the recommendation for trade quality measurement to “those security types and markets for which reliable comparative data are readily available.” Although the TMTF agreed that measuring the quality of trades was an important component to assessing Best Execution, it concurred that measurement is not always feasible given the data availability constraints for fixed income and illiquid trades. The Task Force limited the recommendation to measure the quality of trades to those securities with reliable and readily available comparative data. The Task Force would like to stress, however, that the general approach to Best Execution outlined in the TMG (that is, establishing appropriate processes, disclosures, and record keeping procedures) apply to all types of transactions.

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The Standards of Practice Council is a global committee responsible for assisting AIMR in the maintenance of its Standards of Practice. The Standards of Practice include AIMR’s Code of Ethics, Standards of Professional Conduct, Soft Dollar Standards, Trade Management Guidelines, and future ethical standards developed by AIMR.

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Considering that the TMG does not advocate evaluating Best Execution on a trade-by-trade basis but rather on an aggregate basis, the Task Force disagreed with the assertion that the TMG as written did not apply to pairs-trading, short-selling, and arbitrage strategies. V. Voluntary Nature of the TMG A. Several respondents recommended that the voluntary nature of the TMG be reemphasized and that the TMG clearly recognize the absence of a compliance component. Fidelity and the ICI specifically recommended that the TMG avoid words like “should.” The Task Force avoided language that contravened the voluntary notion of the TMG by purposely not using words that could be interpreted as a requirement, such as “must,” “will,” “shall,” or “is/are required to.” In light of these comments, the Task Force identified instances were the use of the word “should” could introduce ambiguity and, consequently, hinder the usefulness of the TMG. Therefore, the Task Force carefully reviewed the use of the word “should” and balanced the document’s overall tone. The Task Force also added language that clarified that the TMG were a series of recommendations and not standards. B. TRP and the ICAA recommended that the statement encouraging Firms to adopt “as many recommendations as possible” be rewritten to encourage Firms to “adopt as many of the recommended guidelines as are appropriate to their particular circumstances.” The Task Force concurred and adopted the recommendation. It further amended the TMG to recommend that Firms that cannot adopt a particular recommendation implement alternative arrangements that seek to achieve the same goal. VI. Branding the TMG as an Industry Best Practice A. The ICI and Lins did not believe that the TMG represented industry best practices. Although, both respondents thought that the recommendations could assist some advisers, the recommendations did not constitute as a best practice because most industry participants did not follow them. Respondents suggested referring to the TMG “potential approaches” to Best Execution. The term “best practice” was used to denote a “desired practice” from a client’s perspective. To accurately reflect this intent, the Task Force replaced references of “best practice” to “recommended practice.” B. Broby viewed the TMG as a “U.S. version” of best practices. He recommended widening the Task Force to include non-U.S. participants and redrafting the TMG. He further noted that the Regulatory Overview section only referenced U.S. SEC definitions and regulations.

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The Task Force acknowledged that the TMG were influenced significantly by U.S. Best Execution related industry practices and regulatory requirements. Given the nature of the changing environment affecting Best Execution, the TMG are intended to be a “living document” that used U.S. practices as its starting point. Through its SPC, AIMR will update the document periodically to reflect appropriate, global Best Execution practices. VII. U.S. Regulatory Background Lins and the ICAA objected to the factors managers should consider when evaluating Best Execution because they referred to a Broker’s, and not to an investment adviser’s, duty of Best Execution. The Task Force concurred and substituted the contested reference in the U.S. Regulatory Background section with the following: [i]n this regard, the U.S. SEC has recognized that qualitative factors are generally as important as quantitative factors. According to the U.S. SEC, in making its Best Execution determination, “a money manager should consider the full range and quality of a Broker’s services in placing brokerage including, among other things, the value of research provided as well as execution capability, commission rate, financial responsibility, and responsiveness to the money manager.”4 VIII. Parties Involved in Best Execution Several respondents were concerned that the explanatory paragraphs addressing the various parties involved in order execution could confuse readers and detract from the substance of the TMG. AIM and Fidelity, however, disagreed. Fidelity requested that the TMG expand on the Best Execution interdependence of investment managers and Brokers as, from a client’s perspective, execution quality was an end-to-end process that started with the manager’s trade placement, continued through Broker handling and execution, and concluded with clearance and settlement. Fidelity further noted that Best Execution could only be improved on a sustained basis when investment managers and Brokers worked in unison to achieve the same ends. AIM suggested that the TMG elaborate on the Best Execution responsibility of investment managers and traders because it usually was viewed erroneously within the industry as being primarily a function of the trading process. Concerned that the aforementioned paragraph (intended to specify the roles of various parties involved in the execution of client trades and their respective responsibility to seek to achieve Best Execution) could create confusion, the Task Force eliminated references to Brokers and markets and exchanges. 4

Interpretive Release Concerning Scope of Section 28(e) of the Securities Exchange Act of 1934 and Related Matters, Exchange Act Release No. 23170 (Apr. 23, 1986).

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IX. Maximizing the Value of Client Portfolios TRP was concerned that the TMG introduced a “new fiduciary duty” for investment managers to “maximize the value” of client portfolios without considering each client’s unique set of investment objectives and constraints. TRP recommended that, should the reference remain, the TMG clearly state the need for investment managers to consider each client’s investment objectives and constrains when attempting to maximize the value of client holdings. The ETF raised similar concerns. ETF recommended deleting “maximizing portfolio value” references and replacing these with “minimizing transactions costs.” The Task Force amended the TMG to reflect the existing fiduciary duty of an investment manager to maximize the value of a client’s portfolio within the context of each client’s unique investment objectives and constraints. X. Definitions Fidelity recommended that the definition of Best Execution in the “Definitions” section mirror the statements noted in the “Definition of Best Execution” section of the TMG. The TMTF concurred and adopted the aforementioned change. In addition, the TMTF (1) replaced the definition of Broker with language that specified that a Broker refers to a broker, dealer, or automated trading venue engaged in the business of affecting transactions for others and that may provide services or products in addition to execution; (2) eliminated the definitions for Brokerage Arrangement, Commission Recapture Program, Internalization, Preferencing of Orders, Strict Price/Time Priority, and Order Flow Arrangement; and (3) harmonized definitions where possible with those published by the U.S. SEC. XI. Trade Management Oversight Committee (TMOC) A. CGTC, Fidelity and the ICI stated that a TMOC may be appropriate for some Firms, but not for all as oversight of the trading function, for example, may be more appropriately given to a single individual or to different individuals for different aspects of trade management. Fidelity cautioned against having the TMG dictate organizational structure but rather having it identify the characteristics of good oversight. Specifying the explicit structure of the TMOC was not the intention of the TMG. To underscore this structural flexibility, the Task Force included additional language stating that the TMOC could be comprised of one person, multiple persons, or various groups depending on the unique needs of each Firm. In addition, the Task Force bifurcated the proposed TMOC’s Best Execution evaluation and compliance responsibilities by independently recommending that a Firm establish compliance monitoring procedures.

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B. The ETF advised that the TMOC should have representation and buy-in from senior investment professionals including the Firm’s chief investment officer. The ETF further noted that Firms could require additional staff and resources to manage the additional responsibilities. Although the Task Force recognized that buy-in from the Firm’s senior management team would be desirable, it did not believe it to be appropriate for the TMG to recommend that a specific employee be a member of the TMOC as this would impinge on its intended structural flexibility. The staff and financial impact will depend on the structure of the TMOC Firms’ implement. C. GS was concerned that formally documenting the TMOC’s deliberations could pose a potential legal liability to the Firm. In addition to aiding with a Firm’s ongoing Best Execution evaluation process, these records will show regulators and other third-parties the active and demonstrable steps a Firm has taken to improve the quality of its trades. The Task Force, however, changed its original recommendation to “summarize TMOC deliberations” to “retain all documents created for and by the TMOC.” XII. AIMR Soft Dollar Standards Several respondents objected to the recommendation to adopt the AIMR Soft Dollar Standards citing that the industry had not widely adopted the Standards. Many respondents also opined that the linkage to the AIMR Soft Dollar Standards weakened the integrity of the TMG and, therefore, their ultimate acceptance by the industry. The Task Force postponed the inclusion of the recommendation to adopt the AIMR Soft Dollar Standards until these are subject to review and possible revision by AIMR’s SPC. XIII. Trade Measurement A. Several respondents stated that the TMG placed too great an emphasis on quantitative approaches to assess the quality of trades. Most noted that Best Execution assessments encompass qualitative and quantitative determinations and that “measuring” the quality of trade executions was not widely accepted within the industry given its skepticism as to the accuracy and utility of available techniques. The SIA stated that such an approach would be costly for Firms and that it would yield little help in selecting Brokers. In contrast, Fidelity congratulated AIMR for recommending the flexible measuring of the quality of trade executions. The Task Force did not intend to emphasize the importance of trade measurement to the detriment of other critical evaluation factors related to Best Execution. To clarify its

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intent, the Task Force included language stating that measurement is one of numerous factors available to Firms to help them evaluate the quality of trades. B. GS recommended changing all references of Trade Measurement Process to “Trade Evaluation Process.” The Task Force concurred and implemented the recommended change. C. The ICAA was concerned that small Firms may not be able to afford paying a consultant to analyze the cost structure of their trading function. The Task Force did not intend to recommend that Firms hire outside consultants to analyze the cost structure of their trading function. Therefore, the Task Force included language that clarified a Firm’s ability to measure these costs in whichever way best fits the needs of each Firm (i.e., using internal or external resources). D. Broby believed that recommendation 1.A.4. is too ambiguous and open to exploitation by service providers. He added that market impact was difficult to quantify and that trade measurement techniques had not been sufficiently scrutinized by academics and statisticians. Although there are various methods to measure the quality of trades (each of which may be better or worse suited to the unique needs and circumstances of each Firm), the Task Force believed that consistent measurement over time will provide valuable aggregate data that will assist Firms in their quest to improve their Best Execution capabilities. E. Fidelity believed that the TMG should encourage managers to demand, and data aggregators to provide, the formulae used to calculate execution costs. Without transparency, it added, measurement is an empty exercise. This recommendation was not implemented as measurement processes and formulae that consultants use are diverse and considered proprietary information. The Task Force hopes that more industry research is conducted in this area in the future. F. The ETF noted that the quality of execution only could be judged and measured fairly when commissions are unbundled and there was a true separation between payment for execution and Research. In addition, the ETF recommended that the TMG establish a best practice benchmark for Best Execution. Although transparency would increase with the unbundling of execution and Research related costs, this separation is unlikely to happen in the near future given well-routed global industry practices. In addition, the Task Force did not to recommend a single “appropriate” benchmark to measure Best Execution as what may be appropriate will depend on the unique circumstances of each Firm. XIV. Target Plans

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Fidelity, AIM, and the ICI disagreed with the recommendation for Firms to have a brokerage allocation plan or budget. AIM and Fidelity argued that using allocation budgets was contradictory to the process of seeking Best Execution as traders could feel pressured to reach these targets at the risk of Best Execution. Fidelity recommended deleting the recommendation altogether or, at the very least, dropping the word “target” and replacing it with a recommendation that Firms “periodically analyze commission trends and compare commission forecasts versus actual flows.” The ICI underscored the difficulty of implementing targets. The Task Force agreed with and implemented Fidelity’s suggestion by rewording the recommendation to state that Firms should periodically analyze commission trends and compare commission forecasts versus actual flows. XV.

Review of a Brokers’ Financial Condition Four respondents provided significant feedback on the recommendation to conduct a financial evaluation of Brokers. TRP, the ICI, and the ICAA disagreed with the recommendation, while Fidelity suggested means to improve the quality of the reviews. The ICI and TRP believed that the recommendation would be burdensome to Firms and unnecessary given that Brokers are subject to minimum capital and other regulatory requirements intended to ensure their financial stability. TRP added that audited financial statements were no guarantee of financial health and recommended that Firms use the day-to-day Broker interactions to evaluate performance and capacity. The ICI objected to the notion of continuous review believing that an initial review at the onset of the relationship was sufficient. The ICI also requested that the TMG specify the type and depth of this review. The ICAA questioned the practicality of small Firms obtaining and analyzing this financial data. Firms entrusted to manage client funds have a duty to safeguard such assets against undue risks. The Task Force, however, thought being overly prescriptive of what constitutes a Broker’s “wear withal” was inappropriate as the depth of a review would vary between Firms depending on the nature of their relationships with each Broker.

XVI. Broker Selection Criteria Fidelity recommended that the TMG clearly state that the list of Broker characteristics is illustrative in nature and that a formal consideration of each listed factor may be inappropriate in every case. Fidelity also recommended expanding the list to include the following: a. obtain independent financial review of all counterparties; b. establish minimum credit criteria for inclusion on the approved Brokers’ list; and c. monitor approved Brokers periodically.

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The Task Force agreed to underscore that the list of Broker characteristics was illustrative and non-inclusive in nature and that formal consideration of each one of the listed traits may not be appropriate in every case. Although Firms often opt to do so, the Task Force refrained from recommending that Firms obtain an independent financial review of all counterparties believing that reviews (1) are not necessary in all instances and (2) would be financially burdensome, especially for small Firms. The Task Force rejected the recommendation for Firms to establish minimum credit criteria for inclusion on the approved Brokers’ list. The objective of recommending a financial review was not to assess the long-term financial viability of a Broker, but rather to evaluate the probability that a Broker remained a going concern while charged with transacting the trade. The Task Force believed that the need for continuous monitoring of Brokers already was reflected in recommendations 1.A.3.b and 1.C. XVII. Approved Brokers’ List Three respondents provided feedback on the recommendation to develop and implement an approved Brokers’ list. TRP and AIM disagreed with the recommendation. TRP stated that the list could inhibit the use of other Brokers, market centers, or new technologies that could improve a client’s execution quality. AIM believed the list could prevent a trader from executing a particular trade with an unlisted Broker but who may be in the best position to provide Best Execution. In contrast, Fidelity considered the development and use of an approved Brokers’ list to be an industry best practice. The Task Force clarified in the TMG that, on occasion, trading with a Broker not on a Firm’s approved Brokers’ list may be in the best interest of the client. The Task Force further recommended that Firms develop procedures that outline a process to follow when investment managers are contemplating doing business with a non-approved Broker. XVIII. Client-Directed Brokerage Agreements Fidelity believed that the recommendations associated with Client-Directed Brokerage Arrangements were incomplete as they did little to guide Firms and their clients on how to deal with the associated risks. Fidelity made the following three recommendations: (1) The TMG should highlight the risks associated with Client-Directed Brokerage Arrangements and encourage managers and clients to discuss the client’s obligations carefully so as to weigh the potential risks against expected benefits.

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In particular, the TMG should repeat the Department of Labor (DOL) ERISA Technical Release No. 86-1 that states: “A plan sponsor’s decision to direct brokerage transactions must be made prudently and solely in the interest of the participants and beneficiaries. In directing a plan’s brokerage transactions, the sponsor has an initial responsibility to determine that the broker-dealer is capable of providing best execution for the plan’s brokerage transactions. In addition, the sponsor has the ongoing responsibility to monitor the service provided by the broker-dealer so as to assure that the manager has secured best execution of the plan’s brokerage transactions and the commissions paid are reasonable in relation to the value of the brokerage and other services received by the plan.5” The Task Force did not implement the suggested change as the DOL quote indirectly refers to investment advisers and there was concern that inclusion could confuse and detract from the main focus of the TMG. (2) The TMG should suggest that a manager obtain directed-brokerage directions from the client in writing, including the client’s acknowledgement that it has determined that the named Broker is capable of providing Best Execution and that the client understands and accepts its ongoing monitoring responsibilities. If the manager believes that the instructions will be difficult to fulfill without risk to Best Execution, the manager should disclose these risks and suggest other means by which the client may realize the intended benefits of the directed brokerage while reducing the execution risk. The TMG also should recommend that if the client persists in requesting the arrangement, then the client assumes all responsibility for Best Execution. The TMTF concurred with the recommendation to provide additional guidance on Client-Directed Brokerage Agreements. In fact, AIMR recognized additional guidance in this regard was necessary when it developed the AIMR Soft Dollar Standards. The Task Force amended the TMG to include a recommendation that Firms establish policies and procedures that address Client-Directed Brokerage Arrangements, such as those noted in Appendix A of the AIMR Soft Dollar Standards. (3) The TMG should suggest a best practice of establishing a policy for ClientDirected Brokerage Arrangements. This policy should address (a) if managers may accept client directed brokerage instructions; (b) the maximum percentage of commission volume to be directed on a best efforts basis; (c) if managers will accept instructions requesting brokerage be sent to a Broker not on the Firm’s approved Brokers’ list; and (d) how a client’s trade may be removed from a block trade and executed elsewhere.

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Department of Labor, Pension and Welfare Benefits Administration, “Statement on Policies Concerning Soft Dollar and Directed Brokerage Arrangements,” (May 22,1986)

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This issue is addressed in Appendix A of the Soft Dollar Standards, which has been added as a reference to the TMG. XIX. Conflicts A. CGTC, GS, the ICI, the ICAA, Lins, and Fidelity noted that internalization, preferencing, and order flow arrangements were not conflicts of Firms but of Brokers. In addition, GS and the ICI noted that Rule 206(3) of the Investment Advisers Act of 1940 prohibits Firms from acting as principals on trades without making the appropriate client disclosures and obtaining prior permission from the client. Both respondents recommend deleting the recommended disclosure. Although not generally conflicts for Firms, internalization, preferencing, and order flow arrangements may be conflicts of interests for highly integrated Firms. In light of the concerns noted above, the Task Force clarified its intent by replacing recommendations to disclose internalization, preferencing, payments for order flow, and use of principal trades with a recommendation to disclose to clients the use of an affiliated Broker on an agency or principal basis. The revised recommendation would address the conflicts noted in the originally proposed document. B. Lins further added that Client-Directed Brokerage Arrangements do not represent a conflict for Firms since the client chooses the brokerage relationship. Although the Task Force agreed that Client-Directed Brokerage Agreements do not pose conflicts between an investment manager and the directed brokerage client, these arrangements may create conflicts between clients as directed clients may expose nondirected clients to sub-optimal trade executions and higher trading costs. C. The ICI advised explaining what was meant by the phrase “order-routing practices” as the words have a different meaning for Brokers than for Firms. In an effort to eliminate ambiguity, the Task Force replaced all references to “orderrouting practices” with “Broker selection.” D. Lins recommended an additional conflict of interest to be added to 2.B. He suggested that Firms disclose if they are using client brokerage to obtain goods or services that do not constitute Research or brokerage services. The TMTF implemented the recommendation as noted. XX.

Retention of Records The ICAA suggested that the TMG include wording that informs Firms adopting record keeping recommendations that exceed existing legal and regulatory requirements, they may be required to maintain these documents for U.S. SEC inspection for a period of 5 years.

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The Task Force disagreed with the recommendation noting that investment advisers generate many documents that are not specifically subject to regulatory record retention requirements. Though not subject to retention requirements, regulatory examiners may request to review any available documentation. XXI. Applicability to Aggregate Execution Process AIM and the ICI advised clarifying that record keeping recommendations applied to the overall Best Execution process and not to each specific trade. The Task Force implemented the recommendation above by adding “on an aggregate basis” at the end of recommendations 3.A. and 3.C. XXII. Trading Systems Given its subjectivity and complexity, GS recommended deleting section 3.B. GS further noted that the rationale supporting a trading system selection would not provide meaningful information to clients. The recommended documentation supporting the selection of a Firm’s trading system was not intended to be shared with clients but rather to provide meaningful documentation to aid a Firm in its quest to continuously improve the quality of its overall trades. Nevertheless, the Task Force eliminated this specific record keeping recommendation because it felt that it was adequately addressed in the recommendation to retain all documents produced by or for the TMOC.

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