Days of Soft-Dollar Payments May Be Numbered

As the mutual fund industry works to rehabilitate itself from the market-timing and late-trading scandals, recent announcements that Morgan Stanley (MWD Quote) and Massachusetts Financial Services will eliminate their soft-dollar payments for research may presage a trend.

Soft-dollar commissions have long been a part of the asset management industry, but the recent regulatory spotlight on the mutual fund industry has prompted a re-evaluation of their use as payment for research or for directed brokerage, in which commissions are channeled to other securities firms as a trade-off for selling particular funds. Critics say fund shareholders aren't getting the best price for their trades, and ultimately lose value.

"In the beginning, they were like frequent-flier miles or green stamps," that rewarded repeat business, said Nell Minow of the watchdog Corporate Library. "But this is evidence that the market is changing in the way of past scandals. In that respect, it's the end of an era."

While Morgan Stanley and MFS have taken a harder line than some mutual fund companies, other mutual fund operators such as Fidelity and Putnam Investments are cutting back their use of soft dollars. The support of the $7 trillion mutual fund industry may prompt the Securities and Exchange Commission to take up the issue more forcefully.

Mitchell Merin, the head of Morgan Stanley's asset management unit, sent a letter to SEC Chairman William Donaldson on Wednesday announcing the end of soft dollar commission payments for outside research and calling for the agency to revise the rules on fund governance.

"Recent events require all of us in the mutual fund industry to take meaningful steps to maintain public confidence in these products," Merin wrote. "We support the elimination of third-party soft dollar payments in connection with mutual funds."

Robert Pozen, the new nonexecutive chairman of MFS, said his company also has ended the practice and is ready to absorb an additional $10 million to $15 million in trading costs, which won't be passed on to shareholders. The move follows a $225 million settlement with the SEC by its parent company, and an agreement to reduce fees by $125 million over five years. After the suspension of Chief Executive John Ballen and investments chief Kevin Parke, probity rules the roost for the Boston mutual fund company.