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January 3, 2006

OMS Vendors Oppose SEC 28(e) Guidance

By Gregory Bresiger

Some order management system executives have gone into a full-court regulatory press.

They are lobbying the SEC to reverse its opinion that their services don't qualify for alternative commission arrangements. Those used to be called soft dollars. They were recognized under the safe harbor of Section 28(e) of the Exchange Act. OMSs have billed on a soft dollar basis, but that may end.

The SEC, in a recent guidance release explaining how commissions should and should not be billed, said expenditures that are not integral to the execution of orders don't qualify for alternative arrangements.

"Order management systems used by money managers to manage their orders (including OMS developed in-house at the manager and those obtained from third-party vendors) and hardware, such as telephone or computer terminals, are not eligible for the safe harbor as brokerage," the SEC wrote. The regulators said these services are "not sufficiently related" to order execution to qualify for alternative commission arrangements. The SEC asked for comments on its release, setting a November 25th deadline.

Officials at Charles River Brokerage, a unit of the buyside OMS vendor of the same name, wrote in a comment letter that OMSs come within the guidelines of 28(e). Indeed, these officials argued that, for smaller firms, OMSs are critical to achieving best execution. Stephen Schardin, president and managing director of Charles River Brokerage, contended the OMS is critical to the execution process.

"It is clear that the OMS provides trade functionality at the formation of the trade, at the transmittal of the trade execution venues, and at the allocation point of the trade upon its completion," according to Schardin. In an interview with Traders Magazine, Schardin insisted that OMS functionality "falls well within the parameters of Section 28(e) by supporting trade execution."

Nevertheless, an industry observer said that, even if the SEC sticks to its potential prohibition on soft dollars for OMSs, it will probably change little in the trading industry. "We're sensing that our clients are already very careful about how they're using soft dollars," said John Clark, a principal with Cutter Associates, a Boston-based technology-consulting firm. Cutter is an expert in buyside shops. It has both vendors and brokerages among its clientele. And he added that regardless of whether or not the SEC goes ahead with the OMS prohibition the money would be found to pay for OMSs. That's because, he added, that OMSs are critical. But they are usually too expensive for small- and mid-sized firms to build in-house, Clark said.

"It is essential today that firms have these order management systems to get best execution." Clark said. He noted that, for several years, soft dollars have been a declining part of paying for research services.

Schardin concedes the point, noting that only 10 percent of Charles River Brokerage's revenues now come from soft dollars. However, he added that, if the SEC release stands, "it will put some pressure on the smaller firms."

Officials of the other buyside OMSs, LatentZero, Macgregor, Linedata Services and Eze Castle, declined comment.