This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

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."

Services Rendered
Soft dollar payments in 2004
Source: Greenwich Associates
Note: Based on responses from 70 U.S. equity portfolio managers.

The Greenwich Associates report recommends that at the very least, fund shareholders should be told how these commissions work.

"Increased disclosure ... would allow investors to see how much money institutions are paying for research and services, and to judge the value of these transactions in light of their final performance results," said Greenwich consultant Jay Bennett.

Proponents of reform say reducing the use of soft dollars will lower overall investor expenses, though they argue that the outright bans considered in different pieces of proposed Congressional legislation would do more harm than good.

The SEC has convened a special task force to study the issue and hoped to have an initial report of its findings by this fall, said John Nestor, an agency spokesman.

That would mean any real change is about two years in the future, but observers say many fund mangers are already reining in their use of the credits. Massachusetts Financial Services, one of the firms entangled in last autumn's mutual fund scandal, recently announced it would end the use of soft dollars altogether, and other mutual fund companies are said to be mulling the practice. The report also said half of the 279 survey respondents opposed paying for research out of their own pockets, although their increased hiring of buy-side analysts may indicate that some of that research will move in-house.

Westle said the sea change is really just a return to the original legal provisions of the "safe harbor" section of the original legislation covering soft dollars.

"When soft dollar regulations were first adopted, they really provided for very limited use, and they expanded over time," he said. "I don't believe that the SEC ever envisioned what people would do with it."

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $92.81 -0.87%
GOOG $699.13 0.49%
FB $118.00 -0.05%
TSLA $213.49 -4.10%
YHOO $37.00 2.80%


Chart of I:DJI
DOW 17,659.93 +8.67 0.05%
S&P 500 2,055.29 +4.17 0.20%
NASDAQ 4,734.0610 +8.4220 0.18%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs