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January 2, 2007

Wall Street Learns to Share

By Gregory Bresiger, Peter Chapman and Hillary Jackson

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Commission sharing arrangements are making significant inroads into the British stock trading business, and are poised to do the same in the United States. In the United Kingdom, by some reports, about half of all commission dollars will soon be directed to broker-dealers willing to share some of their commissions with competitors.

In the U.S., at least three more brokers-BNY ConvergEx, Miletus Trading and LaBranche Financial Services-have recently joined a slew of other agency and bulge bracket shops in offering CSAs to their buyside clients.

For the sellside, the trend promises to produce both winners and losers. For the buyside, industry executives expect winners, but no losers. And some big money managers are likely to be unaffected.

Driving the trend on both sides of the Atlantic are moves by regulators to clarify the rules governing the use of commissions.

"The single most current question in the mind of the buyside trader," according to John Meserve, president of BNY Jaywalk, "is the implementation of commission sharing arrangements. It's a new tool. It's front and center. It's the way people are addressing the whole unbundling issue." Meserve was speaking at the Security Traders Association's annual conference in October.

"Unbundling" has come to mean the disclosure by a money manager to his clients of the components of its commission payments. The two major components are research and execution.

CSAs caught fire in the U.K. at the beginning of the year because the Financial Services Authority, England's regulator, instituted new rules requiring money managers to unbundle.

At the same time, the FSA clarified its rules surrounding the use of commission payments in such a way that made attractive the practice of broker-dealers sharing commissions.

These so-called commission sharing arrangements allow money managers to unbundle at least some of their payments to their smaller research providers.

Popular Practice

Sharing of commissions between brokers has been a popular, if sometimes, shady practice, for many years. They have caught on recently as regulators pressured fund managers to more clearly detail their commission payments.

The typical CSA permits a money manager to obtain research services from one broker and execution services from another.

The manager doles out its commissions to the "executing" broker, typically a larger bulge bracket or agency shop. That broker then shares those commissions with a second broker, the one providing the research.

CSAs are kissing cousins with so-called soft dollar arrangements, but are considered more respectable from a regulatory standpoint. They both utilize commission payments to acquire third-party research, but CSAs are more transparent, supporters say.

While the CSA has been in use in the U.S. in some form after the 1920s, it is only since July it has become the subject of intense interest. In that month, the SEC released a new interpretation of certain parts of Section 28(e) of the Securities Act of 1934. This is the so-called soft dollar safe harbor.