OHIO PUBLIC EMPLOYEES RETIREMENT SYSTEM 277 EAST TOWN STREET COLUMBUS, OH PERS (7377)

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1 OHIO PUBLIC EMPLOYEES RETIREMENT SYSTEM 277 EAST TOWN STREET COLUMBUS, OH PERS (7377) MEMORANDUM DATE: February 7, 2007 TO: CC: FROM: RE: OPERS Retirement Board Members Chris DeRose Executive Director Jennifer Hom, Director Investments Greg Uebele, Senior Investment Officer External Management Bill Miller, Senior Investment Officer Fund Management Scott Murray Senior Equity Analyst Joan Stack Trading Manager Soft Dollar and Commission Recapture Policy: Regulatory Background and Issues Related to Commission Arrangements Purpose This memorandum offers a brief overview of regulatory changes related to commission arrangements, and provides information as to why such changes require a revision of OPERS Soft Dollar and Commission Recapture Policy. Background In July 2006, the SEC provided interpretive guidance on Section 28(e) of the Securities Exchange Act of Section 28(e) deals with the use of trading commissions to obtain investment research; this section is also referred to as the Safe Harbor provision. (The text of this section is attached.) OPERS current Soft Dollar and Commission Recapture Policy requires modification to be in alignment with the SEC guidance. Traditionally, equity asset managers have paid a commission to brokerage firms for stock trades executed on the manager s behalf. This commission would cover the cost of executing and clearing the trade, as well as for access to the brokerage firms proprietary research (including, reports, conferences, access to analysts etc.). 1

2 A presentation made to the OPERS Retirement Board Members in July 2006 documented how OPERS Internal Equity Investments staff attributed a dollar value to the Wall Street research received; it was demonstrated that through commissions, OPERS was getting proprietary research valued at approximately twice or more the cost to OPERS. Recent calculations show that in 2006, million shares were traded in the internally managed, $6.4 billion Russell 1000 Research Portfolio, at a rate above pure execution cost. Commission Amount Paid Above Pure Execution Rate--Russell 1000 Research Portfolio 2006 Shares Traded Average Commission Rate Average Pure Execution Rate Average Amount Paid Above Pure Execution Rate million $0.038 per share $0.015 per share $0.023 per share Total Amount Commissions Paid Above Pure Execution Rate $3.8 million (164.7 million shares* $0.023 per share) Work by Scott Murray and other OPERS investment staff determined the range of the value of brokerage supplied research. The calculations used in the study have been updated and support the previously mentioned range for the value of brokerage supplied research. Value of Brokerage Supplied Investment Research Low End High End Value of Brokerage Supplied Research $12.6 million $14.7 million Amount of Commission Paid Above Pure Execution $ 3.8 million $ 3.8 million Value of Brokerage Supplied Research Exceeds Amount Paid $ 8.8 million $10.9 million The commission arrangement described above is referred to as a bundled commission; meaning the amount paid as commission included components for both execution costs and proprietary research costs. Over the past few years, there has been a gradual shift in how the SEC and the Wall Street/Investment Management community views commissions. Historically, the term soft dollars was defined as commissions being directed to compensate an independent third party research provider. The rise of electronic trading systems and direct market access has enabled us to identify the execution only cost for a given trade. Thus, any commission payment above the execution only cost in a bundled commission is now construed as soft dollars regardless of whether the payment is for proprietary or third 2

3 party research. Issues Section 28(e) of the SEC Act specifically permits the use of soft dollars for obtaining bona fide investment research. The July 2006 SEC release tightened up the definition of what may be considered lawful and appropriate investment assistance to be obtained through commission arrangements. New in the release is that the SEC has explicitly endorsed the use of third party research, that is, investment research provided by an entity that has no trading capability. For example, research can be paid for by executing a trade with Brokerage Firm ABC, with a part of the commission going to Research Provider XYZ to compensate them for their research product. The SEC release states Third party research can benefit advised accounts by providing greater breadth and depth of research We believe that the safe harbor encompasses third party research and proprietary research on equal terms. Currently, OPERS Soft Dollar and Commission Recapture Policy (dated September 2005) states OPERS will permit its external managers to utilize soft dollar arrangements effectively prohibiting internally managed assets from benefiting from these arrangements. Seeking Best Execution from approved brokerage firms is OPERS mandate, regardless of research products offered. In accordance with best practice, investment staff performs appropriate documentation, monitoring, evaluation and reporting as required by the Investments Compliance and Internal Audit departments. Next Steps It is recommended that OPERS Soft Dollar and Commission Recapture Policy be updated to reflect recent development as outlined by the SEC, and to insure that OPERS internally managed equity funds have full access to quality, cost effective research as do the externally managed funds. 3

4 Attachment Securities Exchange Act of 1934 Section 28(e) (1) No person using the mails, or any means or instrumentality of interstate commerce, in the exercise of investment discretion with respect to an account shall be deemed to have acted unlawfully or to have breached a fiduciary duty under State or Federal law unless expressly provided to the contrary by a law enacted by the Congress or any State subsequent to the date of enactment of the Securities Acts Amendments of 1975 solely by reason of his having caused the account to pay a member of an exchange, broker, or dealer an amount of commission for effecting a securities transaction in excess of the amount of commission another member of an exchange, broker, or dealer would have charged for effecting that transaction, if such person determined in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided by such member, broker, or dealer, viewed in terms of either that particular transaction or his overall responsibilities with respect to the accounts as to which he exercises investment discretion. This subsection is exclusive and plenary insofar as conduct is covered by the foregoing, unless otherwise expressly provided by contract: Provided, however, That nothing in this subsection shall be construed to impair or limit the power of the Commission under any other provision of this title or otherwise. (2) A person exercising investment discretion with respect to an account shall make such disclosure of his policies and practices with respect to commissions that will be paid for effecting securities transactions, at such times and in such manner, as the appropriate regulatory agency, by rule, may prescribe as necessary or appropriate in the public interest or for the protection of investors. (3) For purposes of this subsection a person provides brokerage and research services insofar as he (A) furnishes advice, either directly or through publications or writings, as to the value of securities, the advisability of investing in, purchasing, or selling securities, and the availability of securities or purchasers or sellers of securities; (B) furnishes analyses and reports concerning issuers, industries, securities, economic factors and trends, portfolio strategy, and the performance of accounts; or (C) effects securities transactions and performs functions incidental thereto (such as clearance, settlement, and custody) or required in connection therewith by rules of the Commission or a self-regulatory organization of which such person is a member or person associated with a member or in which such person is a participant. (4) The provisions of this subsection shall not apply with regard to securities that are security futures products.

5 MEMORANDUM OHIO PUBLIC EMPLOYEES RETIREMENT SYSTEM 277 EAST TOWN STREET, COLUMBUS, OHIO PERS (7377) DATE: February 7, 2007 TO: CC: OPERS Investment Committee Members Chris DeRose, Executive Director Jennifer Hom, Director Investments Greg Uebele, Senior Investment Officer External Management Bill Miller, Senior Investment Officer Fund Management FROM: Alan Davidson - Investment Compliance Manager RE: Soft Dollar and Commission Recapture Policy: Proposed Policy Revisions Purpose This memorandum is a summary of proposed revisions to the Soft Dollar and Commission Recapture Policy. Summary The Board established the Soft Dollar and Commission Recapture Policy in June 2003 and revised it in September Despite its seemingly inclusive title, this policy relates solely to the use of Soft Dollars by external managers of public market assets and does not address internal investment staff s use of them. The Board established the Brokerage Policy in November 2001 and has revised it, most recently in August In addition to provisions relating to brokers, it refers to the use of Soft Dollars by internal investment staff. Staff recommends revising the Soft Dollar and Commission Recapture Policy now to eliminate unintended ambiguities between it and the Brokerage Policy by virtue of their overlap in subject matter and to acknowledge additional guidance from the Securities and Exchange Commission (the SEC ) concerning Soft Dollars. At a subsequent meeting, staff will present recommendations for changes in the Brokerage Policy. Those changes, together with the changes now proposed, revise these two policies so that each will relate to a single subject rather than to an organizational unit. For that reason, future revisions to the Brokerage Policy will not affect the changes proposed

6 today nor will they be affected by them. Issues Attached are copies of the current Soft Dollar and Commission Recapture Policy, dated September 2005, and the proposed revision titled Soft Dollar and Other Commission Arrangements, which is dated February A synopsis of significant changes follows, in the same order as headings in the September 2005 text: Title Staff recommends changing the policy s title from Soft Dollar and Commission Recapture Policy to Soft Dollar and Other Commission Arrangements, to conform to the SEC s use of terminology. The term Other Commission Arrangements is meant to include Commission Recapture programs and no change of substance with respect to them is intended or proposed. Scope Proposed changes make clear this policy applies to all transactions paid for through commissions and is not limited to externally managed assets. Legal Authority Staff intends no changes of substance in this section. Brokerage Philosophy This section discusses Best Execution and not, as now captioned, Brokerage. The proposed caption, Best Execution Philosophy, summarizes its content more accurately. It explains the SEC s use of terminology to describe different types of commission arrangements, facilitating clarity in this policy. Proposed revisions make clear that internal staff may use Bundled Commissions to purchase third party investment research services as well as to buy proprietary research from executing brokers. Revisions also make clear that OPERS aspires to comply with the SEC s guidance issued pursuant to Section 28(e) of the Securities Exchange Act of Staff believes OPERS should strive to comply with these standards, even though its activities are neither governed by the Act nor regulated by the Commission. Accordingly, revisions eliminate prior references to standards of the Chartered Financial Analyst Institute. Objectives The revised policy adds provisions concerning Internally Managed Investments and references Ohio Revised Code provisions relative to minority and female owned and controlled firms and to those that are Ohio-qualified agents. Changes also recognize creation of the Investment Division s Broker Review Committee, which helps assure internal staff s compliance with this policy. 2

7 With respect to Externally Managed Investments, proposed revisions acknowledge that market regulators in other countries, such as the United Kingdom, have also adopted applicable regulations similar to those of the SEC that may apply to managers of foreign securities. Roles and Responsibilities The current policy intimates that the Investment Committee will review it once each year but requires the full Board to do so twice a year. Revisions recommend the Committee review this policy at least annually and that the Board do so periodically. The new section adds responsibilities of the Broker Review Committee. Monitoring and Reporting Duties of the Broker Review Committee were also added to this section. Next Steps Staff will continue to work on revising the Brokerage Policy and present it for consideration by the Investment Committee at a subsequent meeting. 3

8 MEMORANDUM To: Investment Committee Ohio Public Employees Retirement System From: Brady O Connell, CFA Kris Ford, CFA Chris Riley Date: February 7, 2007 Re: Soft Dollar Policy Background An important, but often hidden, cost of investment management is the commission dollars paid to brokerage firms to buy and sell stocks on behalf of OPERS and its investment managers. Use of commission dollars, which are considered an asset of OPERS, have come under increased scrutiny lately and we applaud the effort of those seeking to add clarity to this complex aspect of investment management. The policy relates to the use and monitoring of soft dollars, or credits received by OPERS or its managers for paying brokers a commission in excess of the pure cost of executing trades, in order to receive research. This practice of paying up with additional commission dollars is not illegal but should be monitored closely to make sure OPERS is getting the best execution of its trades as well as efficiently acquiring additional research resources that can be used in the investment process. Overview Staff has presented the Investment Committee with revisions to the policy that currently governs the use of commission dollars by OPERS internal and external asset managers when transacting in public market equities, the Soft Dollar and Commission Recapture Policy. The proposal applies to both internal and external investment managers (the legacy policy addressed external and internal portfolio policy separately). When these policies were last reviewed in July of 2005, we commented that OPERS policies were noteworthy in clearly defining best execution and calling for it as the primary goal when executing trades. The proposed version of the policy retains these favorable aspects of the first policies and brings the language in line with SEC guidance. The consolidation of the two policies into one is useful in decreasing the complexity of the issue and viewing both internal and external investment managers on the same footing. We recommend the Committee adopt the proposed changes to the policy as proposed by staff. G:\opERS\wp\memos\Soft Dollar Policy doc Ennis Knupp + Associates vox South Riverside Plaza, Suite 1600 fax Chicago, Illinois

9 Ohio Public Employees Retirement System Soft Dollar and Commission Recapture Policy September 2005

10 TABLE OF CONTENTS I. SCOPE...1 II. PURPOSE...1 III. LEGAL AUTHORITY...1 IV. BROKERAGE PHILOSOPHY...1 V. OBJECTIVES...1 A. SOFT DOLLAR...1 B. COMMISSION RECAPTURE...2 VI. ROLES AND RESPONSIBILITIES...2 A. BOARD OF TRUSTEES...2 B. INVESTMENT COMMITTEE...3 C. INVESTMENT STAFF...3 D. EXTERNAL PUBLIC MARKET INVESTMENT MANAGERS...3 VII. MONITORING AND REPORTING...3 Revision History Policy Established June 17, 2003 Policy Revised September 14, 2005

11 I. SCOPE This policy applies to the trading activities associated with externally managed public market assets of the Ohio Public Employees Retirement System ( OPERS ) Defined Benefit Fund, Health Care Fund and Defined Contribution Fund. II. PURPOSE This policy establishes a framework for the use of commission recapture programs and soft dollar arrangements to minimize total transaction costs while maximizing the value of services received and provide for proper monitoring and oversight. III. LEGAL AUTHORITY In accordance with Ohio Revised Code section , which establishes the fiduciary responsibilities of the Board, the OPERS investment staff will use every effort to obtain the Best Execution as defined in the Brokerage Philosophy section below, with respect to all portfolio transactions. IV. BROKERAGE PHILOSOPHY Best Execution is defined to mean the execution of particular investment decisions at the price and commission that provide the most favorable total cost or proceeds reasonably obtainable under the circumstances. OPERS encourages its external public market investment managers to use a variety of methods and venues for achieving Best Execution: this could include choosing the best broker for the transaction or bypassing the broker entirely. Best Execution does not necessarily mean paying the lowest possible commission fee. A brokerage commission is the fee paid to an agent (a broker) for services rendered as a sum or percentage of a transaction. The broker facilitates transactions and may help reduce total transactions costs for a fee or a markup in price. A brokerage commission is the explicit portion of the total transaction cost. Brokerage commissions are paid for two primary reasons: to compensate the intermediary for execution, and to compensate brokerage firms for providing both internally-generated and independent externally-generated investment research services. V. OBJECTIVES A. Soft Dollar Soft dollars are a commission rebate where a broker pays an agreed-upon amount of the investment manager s research expenses out of commissions already paid to the respective broker. The investment manager then receives third-party research-related goods or services from the broker. OPERS approach is to pay the minimum commission necessary to achieve favorable order execution, considering all explicit and implicit trading costs. OPERS believes 1

12 that soft-dollar payment practices are generally an inefficient means to defray investment expenses, and generally give rise to higher overall program costs. Under typical soft-dollar payment arrangements, commissions tend to be higher than required for favorable execution, since part of the commission payment to the broker is used to pay the investment expenses of the investor. OPERS acknowledges its external managers may have entered into soft dollar arrangements with brokers that may benefit all of their clients as a whole. As a result, OPERS will permit its external managers to utilize soft dollar arrangements as long as each respective manager seeks to obtain best execution on its securities transactions and fully complies with guidance provided by the CFA Institute Soft Dollar Standards or other appropriate regulatory agencies. B. Commission Recapture Commission recapture, or client-directed brokerage arrangements, generally refers to an arrangement involving the redistribution of brokerage commissions back to OPERS. OPERS can receive benefits in addition to execution services from such an arrangement. Typically, these benefits result in the receipt of a rebate on a predetermined percentage of recaptured commissions that increase portfolio market values and enhance total returns. OPERS requires all of its external public market investment managers to use best efforts to execute portfolio transactions at prices, and commissions, which provide the most favorable total cost reasonably obtained under the circumstances. However, to the extent OPERS staff determines through trade execution analysis that commissions generated are greater than execution services rendered, and commission dollars are available for rebate, OPERS will seek to recapture excess commissions. VI. ROLES AND RESPONSIBILITIES The delineation of roles and responsibilities are important for the efficient and effective management of OPERS and the investment assets. The duties and responsibilities of the Board, Investment Committee, Investment Staff, and External Public Market Investment Managers, in relation to soft dollar and commission recapture are as stated below. A. Board of Trustees The Board of Trustees has the responsibility for approving the Soft Dollar and Commission Recapture Policy, including the Policy and Guideline statement for the publicly traded asset classes developed by Staff. The Board, with consultation from the Investment Committee, shall review the Soft Dollar and Commission Recapture Policy, including asset class objectives and guidelines semi-annually to determine if modifications are necessary. 2

13 B. Investment Committee The Investment Committee shall monitor compliance with the Soft Dollar and Commission Recapture Policy as set forth in this document. It evaluates proposals for modifications as needed and makes recommendations for consideration by the Board. The Investment Committee reviews policies on an annual basis C. Investment Staff All commission recapture programs must be approved in writing by the OPERS Director-Investments. Staff is responsible for establishing appropriate procedural documentation. OPERS investment staff: Abides by approved policies. Develops and maintains specific procedures. Recommends changes to policy, with supporting justification. Provides periodic and special reporting to the Investment Committee. Develops and maintains procedures, approved by the Director-Investments, to support the Policy. D. External Public Market Investment Managers Investment managers are fiduciaries and should conduct all their trading activity in the best interest of OPERS and its members, abide by all OPERS Policies and Procedures, and fully comply with the CFA Institute Soft Dollar Standards or other appropriate regulatory agencies. VII. MONITORING AND REPORTING OPERS will only allow its external public market investment managers to utilize Soft Dollar Arrangements and will make the following documentation available to the Investment Committee. OPERS will require its external managers to provide: A copy of its soft dollar monitoring procedures. A semi-annual report documenting the nature, benefit and source of its soft dollar services categorized by either Research or Administrative purpose. Where possible, a semi-annual trade evaluation report, provided by a third-party vendor, analyzing the securities transactions with its brokers. Disclosure required to claim compliance with the CFA Institute Soft Dollar Standards or other appropriate regulatory agencies. 3

14 With respect to Commission Recapture programs, investment staff will monitor the quality of the trade execution results relative to the remuneration received in the form of rebated commissions. A semi-annual evaluation will be performed and a report will be presented to the OPERS Director-Investments and the Investment Committee. 4

15 PROPOSED for ADOPTION Ohio Public Employees Retirement System Soft Dollar and Other Commission Arrangements Policy February 2007

16 PROPOSED for ADOPTION TABLE OF CONTENTS I. SCOPE...1 II. PURPOSE...1 III. LEGAL AUTHORITY...1 IV. BEST EXECUTION PHILOSOPHY...1 V. OBJECTIVES...2 A. INTERNALLY MANAGED INVESTMENTS SOFT DOLLAR ARRANGEMENTS OTHER COMMISSION ARRANGEMENTS...2 B. EXTERNALLY MANAGED INVESTMENTS SOFT DOLLAR AND OTHER COMMISSION ARRANGEMENTS COMMISSION RECAPTURE...3 VI. ROLES AND RESPONSIBILITIES...3 A. BOARD OF TRUSTEES...3 B. INVESTMENT COMMITTEE...3 C. BROKER REVIEW COMMITTEE...3 D. INVESTMENT STAFF...4 E. PUBLIC MARKET EXTERNAL INVESTMENT MANAGERS...4 VII. MONITORING AND REPORTING...4 Revision History Policy Established June 17, 2003 Policy Revised September 14, 2005 Policy Revised February 20, 2007

17 PROPOSED for ADOPTION I. SCOPE This policy applies to purchase and sale transactions involving internally and externally managed public market securities of the Ohio Public Employees Retirement System ( OPERS ) Defined Benefit, Defined Contribution and Health Care Funds that are paid for through commissions. II. PURPOSE This policy establishes a framework for use of Soft Dollar and Other Commission Arrangements, which are defined in Section IV below, to minimize total transaction costs while maximizing the value of brokerage and investment research services received. It also provides for proper monitoring and oversight of Soft Dollar and Other Commission Arrangements. III. LEGAL AUTHORITY In accordance with Ohio Revised Code Section , which establishes the fiduciary responsibilities of the Board, OPERS investment staff will use every effort to obtain Best Execution, as defined in Section IV below, with respect to all transactions. IV. BEST EXECUTION PHILOSOPHY Best Execution means the execution of a purchase or sale transaction at a price and commission or fee that provides the most favorable total cost or total proceeds reasonably obtainable under the circumstances then prevailing. OPERS primary goal in all transactions is to obtain Best Execution. Best Execution does not necessarily mean paying the lowest possible commission. A brokerage commission is the fee paid to a broker-dealer for services rendered and is calculated as a lump sum or as a percentage of the amount of a transaction. Brokerage commissions compensate broker-dealers for executing transactions. Some commissions also compensate broker-dealers for providing investment research services, which are defined as advice, analysis, reports or other expressions of relevant reasoning or knowledge. Amounts by which such brokerage commissions exceed the price of executing transactions are referred to as Soft Dollars. Soft Dollars used to purchase proprietary investment research services generated by a broker-dealer who executes a transaction are included in the cost of such transactions and are referred to as Bundled Commission Arrangements. Soft Dollars used by an executing broker to purchase investment research services from a third party for OPERS are referred to as Other Commission Arrangements. In managing its internal portfolio, OPERS may pay brokerage commissions that include either the price of proprietary or third party investment research services. When it does, 1

18 PROPOSED for ADOPTION OPERS shall make a good faith determination that such price is reasonable in relation to the value of the brokerage and research services it receives. In doing so, OPERS will make a prudent and diligent effort to follow guidance provided to investment managers by regulators such as the Securities and Exchange Commission, which has done so pursuant to Section 28(e) of the Securities Exchange Act of 1934 (the Act ). V. OBJECTIVES A. Internally Managed Investments When selecting broker-dealers for transactions involving its internally managed funds, OPERS investment staff will follow its policies and procedures to choose the firm most capable of providing the brokerage services necessary to obtain Best Execution. Investment staff will also comply with Ohio Revised Code Section (B), which requires the Board to give equal consideration to minority owned and controlled firms and firms owned and controlled by women that otherwise meet the policies and criteria established by the Board. Investment staff will also comply with Ohio Revised Code Section to increase the use of Ohio-qualified agents for the execution of transactions when an Ohio-qualified agent offers quality, services, and safety comparable to other agents otherwise available to OPERS. 1. Soft Dollar Arrangements Internal Equity Management staff will determine which broker-dealers to use in executing Bundled Commission transactions. In doing so, staff will consider its need for research and the cost and quality of services to be obtained through such transactions. Staff will report results of its allocation of Bundled Commission to the Investment Division s Broker Review Committee on a regular basis. 2. Other Commission Arrangements The Broker Review Committee will, at least annually, forecast the estimated amount of credit that will be available to OPERS through transactions involving Other Commission Arrangements. All requests by investment staff to spend these credits must be made to the Committee, which will consider the costs and benefits of such requests and maintain detailed records of its decisions concerning them. 2

19 PROPOSED for ADOPTION B. Externally Managed Investments 1. Soft Dollar and Other Commission Arrangements OPERS permits its public market external investment managers to utilize Soft Dollar and Other Commission Arrangements as long as they seek to obtain Best Execution of their transactions and to comply with Section 28(e) of the Act and/or other comparable laws and regulations, such as those of the Financial Services Authority of the United Kingdom. 2. Commission Recapture If an OPERS commission recapture agent, in a transaction it reviews, determines commissions generated by an external equity manager exceed the cost of execution services rendered, and if commission dollars are available for rebate, it will seek to recapture the excess commissions. Any commissions recovered will be returned to the portfolio from which they were generated. VI. ROLES AND RESPONSIBILITIES The delineation of roles and responsibilities is important for the efficient and effective management of OPERS and its investment assets. The duties and responsibilities of the Board, Investment Committee, Investment Staff, Broker Review Committee, internal Investment Staff and External Public Market Investment Managers, in relation to Soft Dollar and Other Commission Arrangements, including Commission Recapture, are as stated below. A. Board of Trustees The Board of Trustees is responsible for approving the Soft Dollar and Other Commission Arrangements Policy. The Board shall review this policy periodically to determine if modifications are necessary. B. Investment Committee The Investment Committee shall monitor compliance with the Soft Dollar and Other Commission Arrangements Policy as set forth in this document. It shall evaluate proposals for modifications of the policy, as needed, and make recommendations concerning it for consideration by the Board. The Investment Committee shall review this policy and its results at least annually. C. Broker Review Committee The Broker Review Committee is responsible for recommending to the Director- Investments the annual commission targets to be generated through Other Commission Arrangements and for determining which investment research services 3

20 PROPOSED for ADOPTION to purchase with such commissions. It will also monitor the use of Bundled Commissions by the Internal Equity Management staff. It will report on Bundled Commissions and Other Commission Arrangements to the Director-Investments and to the Investment Committee, as appropriate or at least annually. The Committee is also responsible for recommending changes to the Soft Dollar and Other Commission Arrangements Policy and for maintaining appropriate documentation of its activities. D. Investment Staff All Commission Recapture programs must be approved in writing by the Director- Investments. Investment staff is responsible for abiding by all approved policies. E. Public Market External Investment Managers OPERS will require its public market external investment managers to report, as appropriate, concerning their efforts to achieve Best Execution of securities transactions and their compliance with Section 28(e) of the Act and/or other applicable laws and regulations. VII. MONITORING AND REPORTING Investment staff will provide the following documentation to the Investment Committee: A. Internally Managed Investments The Broker Review Committee will report on OPERS Soft Dollar and Other Commission Arrangements expenses and the investment research services purchased with them whenever requested by the Committee but no less frequently than annually. B. Externally Managed Investments With respect to Soft Dollar and Other Commission Arrangements, investment staff will require each of OPERS public market external managers to provide: A copy of its monitoring procedures. A semi-annual report documenting the nature, benefit and source of services obtained through Soft Dollar and Other Commission Arrangements. A statement demonstrating compliance with Section 28(e) of the Act and/or other comparable laws and regulations. Where possible, a semi-annual trade evaluation report, provided by a third party vendor, analyzing transactions with broker-dealers. With respect to Commission Recapture programs, External Management staff will monitor the quality of trade execution results relative to the remuneration received in 4

21 PROPOSED for ADOPTION the form of rebated commissions. Staff will periodically present reports concerning them to the Director-Investments and to the Investment Committee. 5

22 Soft Dollar and Commission Recapture Policy Regulatory Background and Issues Related to Commission Arrangements Scott Murray, Senior Equity Analyst Joan Stack, Trading Manager Presentation to the Investment Committee February 20, 2007

23 Traditional Commission Model Bundled Commission 4.5 Cents Per Share Covered* Execution Cost Proprietary Research *OPERS Commission rate for Full Service Executions including research component. 1

24 New Commission Model Unbundled Execution Cost Commission 4.5 Cents Per Share Covers* 1.5 Cents for Execution Cost 3 Cents for Proprietary Research Proprietary Research *OPERS Commission rate for Full Service Executions including research component. 2

25 Value of Brokerage Supplied Investment Research Low End High End Value of Brokerage Supplied Research $12.6 million $14.7 million Amount of Commission Paid Above Pure Execution $ 3.8 million $ 3.8 million Value of Brokerage Supplied Research Exceeds Amount Paid $ 8.8 million $10.9 million 3

26 The SEC has recently explicitly endorsed use of 3 rd Party Research Third party research can benefit advised accounts by providing greater breadth and depth of research We believe that the safe harbor encompasses third party research and proprietary research on equal terms. * *Quote from SEC July 2006 publication Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934 page 50. 4

27 OPERS currently uses commissions from internally managed equity assets for proprietary research only (Policy) Investment staff seeks revision to use commissions from internally managed equity assets for independent 3 rd party research 5

28 Soft Dollar and Commission Recapture Policy Proposed Policy Revisions Alan Davidson, Investment Compliance Manager Presentation to the Investment Committee February 20, 2007

29 Introduction Revisions reflect the SEC s latest guidance and trends noted by Joan Staff recommends combining all Soft Dollar provisions in one policy 1

30 Title, Scope and Legal Authority Title is descriptive of text and industry trends Applies to internal and external transactions paid for through commissions No change in legal authority 2

31 Philosophy and Objectives Adopts SEC terminology Expressly authorizes paying for third party research with commissions Sets SEC s Section 28(e) rules as a best practices standard 3

32 Roles, Responsibilities and Monitoring Clarifies review responsibilities of Investment Committee and Board Recognizes creation by staff of Broker Review Committee 4

33 Next Steps 5