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April 30, 2004

Rating Sellside Services

By Peter Chapman

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Software Made for Buyside Spendthrifts

Money managers, on a drive to lower commissions and cut brokers, have found a new tool to weigh up the sellside.

The technology, which is called commission evaluation software, lets the buyside rate the services it receives from brokers. The ratings are used to critique the brokers and assign monetary values to their services. Those values can be used to determine commission levels. And that, for some brokers, is bad news.

"This is a step towards valuing brokers' services," said Ellen Hunt, chief executive of FinancialSockets, a vendor of the software. "It allows the buyside to equate a dollar amount to each of the services their brokers provide."

FinancialSockets and Britain's Rontech are two of the more prominent vendors in the space, marketing the BrokerSelect and 4TEUS applications, respectively. In addition, larger money managers, such as Deutsche Asset Management with its BrokerMerit application, have built their own systems.

Fueling interest in the technology is a drive to reduce costs and keep regulators at bay. The Securities and Exchange Commission in the U.S., and the Financial Services Authority in the U.K., are studying fund managers' costs. They want to be sure the buyside is using its commission dollars wisely and reporting a sufficient amount of cost data to its shareholders.

At the same time, the recent three-year bear market forced the buyside to try to lower its transaction costs, both external and internal. External costs are commissions. Internal costs include market impact and opportunity lost.

Finally, in the U.S., a regulatory push to root out illegal trading practices is forcing the mutual fund industry to rethink its sellside relationships. All told, it means the buyside is getting tougher with its brokers.

Fidelity Investments and MFS Investment Management, two of the world's largest fund managers, are leading the changes.

MFS, for its part, recently announced it would no longer pay its brokers a bundled rate for both research and executions. The announcement coincided with an agreement by MFS to pay upwards of $300 million in compensation and fines to settle charges of illegal trading.

Robert Pozen, the non-executive chairman of MFS, said in a conference call that MFS is "getting off soft dollars for sales, research and market data. We're going to pay cash out of our own pocket. We want to pay for research that is valuable and not just pay five cents per share for research that we don't think is valuable." MFS aims to reduce its average commission charges down to four cents per share.

Fidelity isn't going as far as MFS, but does want brokers to itemize their bills. In March, it asked the SEC to require broker dealers to place a dollar value on the research services they provide to the buyside. Currently, charges for research, sales and trading are bundled into a single commission payment. Costs are not separately broken out.

Fidelity even went so far as to recommend the SEC "consider whether to prescribe a methodology that broker dealers must follow in computing the value of proprietary soft-dollar research."

Hard Dollars