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February 24, 2006

Confronting the New World of Commissions

By Gregory Bresiger

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The Securities and Exchange Commission is expected to require the buyside to deliver more information about its use of commission payments.

That's giving commission management software vendors both a boost and a headache. Systems that can deconstruct a commission payment or assess the value of a broker's services will be much in demand over the next year, according to vendors.

"There will be a growing need for these systems," said Stephen Parker, chairman of the U.K.-based vendor Rontech. "We must have systems that will drive down the cost of alpha," added Ellen Hunt, chief executive of Financial Sockets.

Still, some of the players in this business will be challenged to find solutions to the complexities of commission management.

"Until the regulators make absolutely clear what they require, we're going to have problems," Parker said. Rotech is one of five commission management software compliance vendors that are scrambling to help the buyside keep up with a fast changing regulatory environment.

The SEC, which last year issued an interpretative release, has promised to release new commission disclosure rules this year. These are expected to spell out how much detail money managers must give their clients regarding how their commission dollars were spent. A gaggle of vendors is promoting software for the buyside that they claim provides more effective commission tracking.

The Basics

Commission management applications generally include features such as broker evaluations. These are used by fund managers who want to know how and why their commission dollars are distributed. Brokers with the best research receive the highest commission allocation.

Commission management software also provides fund managers with the ability to monitor actual commission spending and to compare it with what was originally budgeted for each broker. Reporting consists of broker scorecards. Client soft dollar reports and commission management reports are included in the reporting sections.

Three factors-both regulatory and market related-are increasing the demand for these specialized commission management systems offered by Rontech and others.

First, the regulators in the United Kingdom are tightening the rules governing the use of commissions and broadening disclosure requirements. The U.K.'s new tougher disclosure requirements-rules that clarify how and where commission dollars are spent-went into effect this year. The SEC recently tightened its guidelines that define what can be paid for with commission dollars. It is expected to issue new disclosure rules later this year that will be "compatible" with the FSA approach. That means documenting how commissions are split between research and trading.

Second, giant money manager Fidelity Investments has been pushing brokers to unbundle.' This means that Fidelity pays separately for research and transaction services. Hard dollars are paid for research and reduced commissions for executions. (See Traders Magazine, December 2005).

Unbundling has raised questions about the value of research and increased the demand for commission tracking services. Some of those questions are posed by fund companies looking to lower expense ratios as one way of achieving better returns.

Third, some buyside commission management systems are flawed, according to several vendors. They may not meet the SEC's new commission disclosure standards.

Firms Not Prepared