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October 19, 2006

Industry Divided over Value of Recapture

By Nina Mehta

Also in this article

  • Industry Divided over Value of Recapture
  • Page 2

Commission recapture firms are worried. They fear their programs, which ensure that plan sponsors are rebated some of the commissions paid to brokers for executions, will be elbowed aside by commission-sharing arrangements, or CSAs.

Todd Burns, president of Lynch, Jones & Ryan, a subsidiary of BNY Securities Group, the largest global commission recapture firm, said this development is occurring in the U.K. and could hurt institutional clients by depriving them of the ability to recoup some of their commission payments.

Other executives at commission recapture firms agreed with him at a Bank of New York-sponsored panel in August.

Regulatory changes in the U.K. last year and in the United States this past summer are expected to increase investment managers' use of CSAs.

These arrangements enable a money manager to execute trades with a broker who builds up a kitty of the client's commissions. Those funds can then be used to pay an investment manager's research providers.

The executing broker in a CSA maintains a list of the research providers and handles the disbursement of the payments for the money manager, based on the manager's instructions. These programs are considered attractive because of their simplicity and because they separate the cost of both proprietary and independent research from the cost of brokerage.

Less Opaque

The U.K.'s Financial Services Authority has been ahead of the Securities and Exchange Commission in championing these arrangements over traditional soft-dollar or "softed" commissions, which are less transparent. Both regulators now agree that CSAs-as long as the participants meet various requirements-provide transparency into how client commissions are used.

Burns noted that while more transparency is good, CSAs do not solve the twin problems that investment managers may be buying too much research and overpaying for what they get. For decades, commission recapture programs have served as a cap on an investment manager's level of spending for research.

Burns said CSAs and commission recapture programs should exist side by side, as recapture programs traditionally did with soft-dollar arrangements.

But large full-service brokers in the U.K. have now exited the commission recapture business. Burns and other recapture execs observed that Goldman Sachs, UBS Securities and Citigroup no longer execute recapture trades in the U.K.

David Rothenberg, director of the implementation services division at Russell Investment Group, noted that this group of "competitive entities" had apparently decided to exit the commission recapture business at the same time because the business was not sufficiently profitable for them.

The recapture execs also said that large brokers apparently see CSAs as a means of shifting away from recapture, since CSAs separate the costs of execution and research, thereby inserting more transparency into how client commissions are used. The brokers' notion-erroneous from the recapture perspective-is that this transparency will reduce the amount paid for research, making recapture unnecessary.

The departure of a handful of large brokers impacts the commission recapture business because many money managers like trading with them. Those brokers can also execute orders in many regions. Investment managers using them therefore don't have to search out brokers in, for example, Australia or Denmark.