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February 24, 2006

A Dying Practice

By Nina Mehta

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  • A Dying Practice

Last July, Bank of New York purchased commission recapture broker

Lynch, Jones & Ryan from Instinet Group for $159 million. The deal is seen as a feather in BONY's cap at a time when many believe the commission recapture industry is poised for decline.

"This is not a dying business," says Todd Burns, president of LJR. "It's gradually growing for us. But it is consolidating." He says it's consolidating because clients are looking for brokers to provide services across a variety of asset classes-domestic equities, domestic fixed-income and international-along with comprehensive reporting systems and client services.

"It's an industry where the smaller providers are gradually disappearing and there will eventually be just a few firms," the exec adds.

That scenario is plausible, observers say, in an environment where there is greater unbundling of research and execution costs and average commission rates continue to shrink. Consolidation could increase the business prospects for some firms even as the pool of available commissions gets smaller.

Tom Conigliari, a Goldman Sachs executive in charge of third-party research and institutional brokerage, said recently that commission recapture will eventually be priced out of the market by falling commissions. He said Goldman is already seeing a reduction in demand for commission recapture.

Declining rates decrease the incentive for Wall Street brokers to offer recapture services. Full-service brokers earn less on those transactions since they're giving most of the commission to the recapture broker.

According to buyside traders, at least one large broker insists on retaining a minimum amount on low-commission recaptured trades. Others are rumored to be scaling back their recapture business or pulling out of broker networks.

All kinds of trades can be recaptured, says Quinn Zimmerman, global head of commission recapture at Russell Investment Group, but high-touch trades are "best served as commission recapture targeted trades." He adds: "If a manager is utilizing low-touch trades that make less sense from a commission recapture standpoint, then the client has achieved what commission recapture set out to do-which is to lower the total expense of trading."

Richard Kos, president of Kos Consultants in Connecticut, notes: "With technology and direct market access solutions playing a bigger role in trading, commissions will decline even more, so managers will be able to trade at execution-only rates that are probably as low as what sponsors are getting with commission recapture. Why would a plan pay 4.5 cents per share to get back 3 cents per share, when it could pay 1.5 cent a share and be done? The answer is, it wouldn't."

How it Works

The practice of commission recapture, which began gaining ground in the 1970s, involves brokers giving back a portion of the commissions they get from money managers to the plan sponsor or underlying fund. Commission recapture is used by plan sponsors and institutional accounts to recoup some of the cost of commissions by directing their investment managers to use a commission recapture broker.