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April 30, 2004

Her Majesty's Commissions

By Editorial Staff

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In the U.S., they are known as soft dollars.' In the U.K., they are known as soft commissions.' But in both countries the pressure is on to make them hard.

The U.K. kicked off the latest round of table pounding over the use by fund managers of commissions to pay for services other than executions. That was back in 2001, when Paul Myners authored a report of behalf of Her Majesty's government that criticized this practice.

The fallout led the Financial Services Authority (FSA), Britain's securities industry regulator, to issue Consultation Paper 176 last April. That document, which also took a negative view of bundled commissions, called for their unbundling. Under this plan, Britain's fund managers would pay for research and other products out of pocket. They would use customers' commission pounds strictly for executions.

Meanwhile, the U.S. Securities and Exchange Commission got into the act late last year, although in a less dramatic fashion. That's when it issued a concept release, a document which asked whether money managers should disclose more of their trading costs.

That rather dry questionnaire is at the forefront of a white-hot issue because of the scandals that have rocked the mutual fund industry. Some of the country's largest and oldest fund families have been fined for such infractions as improper fund trading and directed brokerage.

With reform in the air, institutions' payment practices are under the microscope as never before. Now regulators in both the U.S. and the U.K. are weighing whether to mandate unbundling. The FSA appears to be softening its stance in favor of a market-driven solution. The SEC is still undecided.

At the same time, the industries on both sides of the Atlantic are moving to make hard or monetarize' those soft payments. Money managers, often with the help of their brokers, are trying to actually calculate the value of research. The idea is to break the commission down into its two primary components: research and execution.

Whether non-execution services are completely stripped from the commission remains to be seen. There is not much appetite on the buyside and sellside for this approach. A notable exception is the Massachusetts Financial Services Co. The big money manager has vowed to pay separately for research and trading.

Stephen Parker is a Brit with ringside seats in the debates. He's also head of a software company, Rontech, that could profit from the possible changes. Rontech, a three-year old U.K. start-up, sells 4TEUS (pronounced forteous), a commission evaluation application. The product has been installed at 10 large fund management firms and their brokers in the U.K and continental Europe. The 20-person company is actively pursuing U.S. business and plans to open a stateside office later this year.

Parker previously ran Tempest Consultants, a research outfit that produced reports ranking the quality of brokerage research, sales and trading services.

Technology Editor Peter Chapman sat down with Parker to discuss the unbundling situation in the U.K. and the U.S. as well as his technology.

Traders: FSA CEO Tiner said recently the regulator may allow the market to work out a solution. That forced unbundling is off the table. What's the situation in London?