The NASD Mutual Fund Task Force (the �Task Force�) recently issued its report on and recommendations with respect to the use of soft dollars and disclosure of transaction costs. The report can beread in its entirety on the NASD website.

Hedge fund advisers should be aware that the Task Force recommended that the Securities and Exchange Commission (the �SEC�) should consider making compliance with Section 28(e) of the Securities Exchange Act of 1934 (the �1934 Act�) mandatory for all discretionary investment advisers, whether or not such advisers are registered with the SEC, and that the SEC recommend to the Department of Labor and the federal banking regulators that they require all other discretionary investment managers not subject to SEC jurisdiction to comply with the safe harbor of Section 28(e). This recommendation should come as no surprise given the composition of the Task Force. At least half of it members are representatives of major mutual fund complexes and many of the members also hold prominent positions with the Investment Company Institute (�ICI�). As you may recall, the ICI was an outspoken supporter of the recently adopted SEC rule that will require most hedge fund advisers to register.

The Task Force unanimously agreed that the soft dollar safe harbor provided in Section 28(e) of the 1934 Act should be preserved. The Task Force, however, recommended that the SEC narrow its interpretation of the scope of the safe harbor to protect only traditional brokerage execution services, the provision of reports, advice, and analyses, and the �intellectual content� of research. The Task Force proposed that the SEC define �intellectual content� as �any investment formula, idea, analysis or strategy that is communicated in writing, orally or electronically and that has been developed, authored, provided or applied by the broker-dealer or third-party research provider (other than magazines, periodicals or other publications in general circulation).�

In attempting to treat hedge fund advisers similar to mutual fund advisers, the Task Force failed to take into account that hedge funds operate pursuant to a statutory exemption which is based on the premise that hedge fund investors require less protection under the Federal securities laws than do mutual fund investors. The soft dollar arrangements for hedge funds are typically a contractual matter pursuant to which the sophisticated investor specifically agrees to the soft dollar activities of the adviser in the subscription agreement. If failure to remain within the safe harbor is interpreted by the SEC as a breach of fiduciary duty under the Investment Advisers Act of 1940 that cannot be contracted away by the advisory client, it is unclear whether hedge fund advisers will be able to continue to define by contract under state law the scope of permitted soft dollar practices. We will keep you apprised of further developments in this area.

Additionally, with respect to mutual funds, the Task Force recommended that the SEC mandate expanded disclosure to fund boards about soft dollar practices to ensure that every fund board understands the types of information that should be reviewed in exercising effective oversight over an adviser�s soft dollar practices. The Task Force also recommended that the SEC mandate expanded disclosure to mutual fund investors regarding soft dollar practices, including enhanced disclosure requirements to require a fund to state whether it obtains third-party research through soft dollars and whether it obtains proprietary research through soft dollars.

The Task Force also made several recommendations regarding the disclosure of transaction costs of mutual funds, including that the adviser supply fund boards with its policies and procedures for monitoring transaction costs and brokerage allocation, and that additional disclosure be provided to shareholders regarding transaction related costs.

Note:

White & Case LLP represents hedge fund sponsors and advisers, prime brokers, and administrators through its 38 offices in 25 countries around the world. For further information on the White & Case hedge fund practice, contact:

Jay B. Gould, Esq.
White & Case LLP
San Francisco, California 94111
415-544-1112 (O)
310-800-6500 (C)
Jgould@whitecase.com