Soft Dollars Are Falling Hard
Mutual funds and investment managers cut their use of indirect brokerage payments by almost 20% last year as they eyed the likelihood of the Securities and Exchange Commission curbing the sometimes controversial practice.
According to Greenwich Associates, an institutional investment consulting group, the use of "soft dollars" -- a means to pay brokerages for services through commission revenue rather than direct payments -- dropped by 18% in 2003. The difference was a direct result of SEC rumblings that tackling abuses of the practice is high on its agenda for reforming the securities industry, the consulting group said.
"The declines in soft dollar usage reflect the expectation that in the current environment, soft dollars are unlikely to escape regulatory action," Greenwich Associates consultant John Colon said. "As that perception takes hold, we expect to see even deeper cuts in the future, either in the form of across-the-board reductions in soft dollar usage, or in a paring back of the types of research and services purchased with soft dollars."
While soft dollar credits can be used by mutual funds to pay for independent research -- the original intent of SEC rules drafted in the mid-1970s -- a redrafting of those rules in 1986 provided "a lot of wiggle room" in subsequent interpretations, said Jay Baris, a partner at the law firm Kramer Levin Naftalis & Frankel.Investment industry sources said mutual funds and advisers would often apply an elastic sensibility to soft dollars, using them to pay for feature status with brokerages, as well as custodial costs and legal fees. In the most egregious cases, soft dollars were used for travel and health club bills, as advisers argued these expenses ultimately benefited investors because they helped generate investment ideas. The issue loomed large as the mutual fund scandal uncoiled last fall, and soft dollars were identified as a hidden cost to investors, along with other fees. "At a minimum, it has to be disclosed," said Tom Westle, a partner at the law firm Blank Rome. "No shareholder I know of understands that brokerage expenses are not part of the operating expense of the firm, but [of] the fund. Investors don't realize it's an added expense to operate the fund."
Soft dollar payments in 2004
|Source: Greenwich Associates
Note: Based on responses from 70 U.S. equity portfolio managers.
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