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January 3, 2006

Unbundling Looms

By Gregory Bresiger

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The Securities and Exchange Commission last month gave money managers the green light to pay for research services with their clients' commission dollars. But that didn't stop the country's largest buysider from declaring open war on the practice. Fidelity Investments struck a deal with Lehman Brothers recently to pay for Lehman's research with its own hard-earned cash rather than that of its millions of small investors. It is pursuing similar deals with other brokers.

As part of its campaign, Fidelity has also publicly egged on its many competitors to do the same and use commissions strictly for executions. Fidelity's move to decouple its payments for research from those for executions was not a complete surprise to those in the trading industry. The buyside gorilla had declared its willingness to unbundle in a letter to the SEC just last year.

But actually doing so has created a stir on the Street. Executives are now trying to figure out if more firms are likely to follow in Fidelity's footsteps. And, if so, what will be the likely impact on the bottom lines of both the sellside and the buyside?

It's all very speculative at this point. "It's too early to tell," Larry Leibowitz, chief operating officer of UBS' equities operation told Traders Magazine. "There has been a dance [between the buyside and the sellside] for the last year or so. The real question is: Do we go to full unbundling like Fidelity is claiming it is doing or do we just end up with more disclosure?''

Tougher Disclosure

More disclosure is extremely likely, industry sources say. Money managers are asking their brokers for help in breaking out their commissions between research and executions. And they are getting it.

"We work with our clients to help them solve their problems," Leibowitz said. "Part of that is helping them with disclosure."

Not everyone is as circumspect as Leibowitz about the future of unbundling. Some are convinced the great unraveling has begun.

"I think there is a very good chance that the rest of the industry will follow Fidelity's lead," said Ken Worthington, a securities industry analyst with CIBC World Markets. And if that happens, he adds, revenues for "the cash equities industry will inevitably decline." He didn't provide a figure, but said Fidelity's action was already having an effect.

"We believe these actions," Worthington wrote in a recent report, "will encourage mutual fund boards and regulators to force other asset managers to unbundle." Others agree.

"Fund boards will definitely go for unbundling because it will lead to greater transparency, which everyone wants," according to Mike Keady, an industry consultant. Keady, a former Plexus Group partner, is an advisory board member of the Mutual Fund Directors Forum in Washington, D.C. The group is a non-profit organization representing independent directors. Keady also runs his own firm, Fiduciary Investing Practices. Keady expects the Mutual Fund Directors Forum to examine unbundling.