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April 1, 2003

Soft-Dollar Practices Need Reform?

By Gregory Bresiger

Soft-dollar rules, enacted by the SEC in 1975 and modified 11 years later, have not kept up with current trading practices, a prominent trading executive has told Congress.

Harold Bradley, senior vice president of American Century Investment Management, said that Congress needs to understand how the 1975 section 28(e) amendment encourages investment managers to use commissions paid by investors as a source of unreported income, which can then be used to pay some of the managers' expenses.

Bradley, speaking to a U.S. House of Representatives Subcommittee, called for reform of soft-dollar practices. He noted that "commissions should be negotiated and disclosed as a percent of the dollar amount of each trade rather than as a per-share charge."

Why is the latter practice outdated?

"Commission rates, measured in cents per share, have moved very little since 1986 when the SEC liberalized the research under section 28(e). Now the pool of equity trading volumes eligible for soft dollar use is expanding," Bradley told the lawmakers. "At the end of 2001, the SEC expanded its interpretation of the safe harbor to cover flat riskless principal trades by market makers in Nasdaq securities," Bradley continued. That action, he noted, reversed a longstanding SEC policy that such trades were not covered by the safe harbor of section 28(e). He noted that managers, losing huge amounts of assets, are facing pressure to find new sources of income.

Bradley warned of the "inherent conflict of interest" in some soft-dollar arrangements. One of the symptoms of the problem, Bradley noted, is "the inadequacy of audit trails, the unrecorded nature of many soft-dollar arrangements and the mutual benefit derived by industry players who work to preserve the opacity of the payment system."

Bradley says the solution to the problem is improved audit and disclosure standards. As reported here last month, the House Financial Services Committee has begun to look at trading costs.