As the mutual fund industry works to rehabilitate itself from the market-timing and late-trading scandals, recent announcements that Morgan Stanley ( MWD) 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.
"We no longer want to be a participant in this arrangement, which is not transparent and in the long run is not good for shareholders," Pozen said. He said he will testify before the Senate Banking Committee next week, and urge the SEC to revert to its pre-1986 guidelines on the use of soft dollars, which he said were not so broad and were better-suited to preventing the abuse of these payments. "People in independent research and independent market data firms say this will hurt their business, because people won't want to pay cash," he said. "My response is that if they provided a valuable service, people will pay. If they don't, people won't pay." Putnam Investments, another firm disgraced by revelations that its funds were used by market-timing hedge funds, is cutting its soft-dollar payments in half and moving to greater use of bulk trades. The new policy comes too late for ousted chief executive Lawrence Lasser, whose stewardship pushed the company into having to settle a misconduct claim with the SEC by agreeing to pay back investors, limiting employee trading and appointing a compliance director. The SEC hasn't yet decided the amount of the fine. In a prepared statement, Richard Block, the director of global equity trading, said Putnam is changing its ways. "While we continue to place all trades on a best execution basis, we believe that the elimination of commissions for sales and the reduction of more than 50% of soft dollar payments for third-party research and brokerage services will better serve the interests of our shareholders as we continue to increase our use of alternative trading venues," he said. Fidelity Investments, which has remained untainted by the market-timing scandal, also has joined the repentant chorus. "The commission should require mutual funds to quantify and separately report soft dollar research expenses in dollars and as a percent of assets," the firm wrote in a letter to the SEC, saying it should be reported in or near a fund's expense table. "The commission should consider whether these expenses should be included within funds' expense ratios as well, but it may be preferable to defer inclusion in the expense ratio to allow the commission an opportunity to evaluate the comparability of this data across different funds and fund complexes." Steven Crawford, the outgoing chief financial officer of Morgan Stanley, said Thursday in a conference call with analysts that the bottom-line cost to the asset management business hasn't been determined, and won't be for a while. "The only thing we can do is make sure we have the most competitive cost structure and best execution for our clients," he said. "It's just a little too early to speculate how all these changes are going to come together and impact the financial situation of the business."