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Elaine Wah

Modern Markets, Modern Metrics - A Blog By IEX

In this blog by IEX's Elaine Wah, the newest public exchange looks to refute public claims that the metrics it uses are designed to inflate its own volume numbers and mislead people.

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September 10, 2007

Soft Dollar "Discussion" Revs Up

By Peter Chapman

One of the U.S. Senate's most powerful members has declared dead on arrival Securities and Exchange Commission Chairman Christopher Cox's plea to eliminate soft dollars.

Sen. Charles Schumer (D-N.Y.), a member of the Senate Banking Committee, is blasting Cox for his May letter to both houses of Congress calling on legislators to "repeal or substantially revise Section 28(e) of the Securities Exchange Act of 1934."

Schumer, a self-described champion of independent research, chastised Cox in July both in a letter and during a Senate hearing.

"I believe there are significant drawbacks to an approach that includes drastic legislative changes that may create far-reaching negative effects on the investment research industry," Schumer told Cox in his letter. "This may be particularly true when those legislative changes are made without first fully exploring available agency-level solutions."

Section 28(e) is the part of the Act that allows investors to pay more for trades than they are worth in order to obtain research. It has been the subject of near constant debate since it became law in 1975.

Rather than dismantle 28(e), Schumer wants the SEC to further regulate soft dollars with new disclosure rules. The SEC stated it would do so last year. "These rules are both appropriate and necessary," Schumer wrote.

At the hearing, the senator reiterated his position that legislative action was unnecessary as there have been no recent indications of abuse of 28(e). Plus a repeal of 28(e) could potentially harm the market for independent research. "I've always believed there should be a vibrant independent research industry," he said.

Schumer also pressed the chairman for the disclosure rules. Cox said he was "awaiting recommendations from the (SEC's) Division of Investment Management," adding that he expected them "ASAP." Industry sources tell Traders Magazine any new rules are unlikely to surface before the end of the year.

(A transcript of the Schumer-Cox parley at the July 31 Senate hearing is this September 2007 issue of Traders Magazine.)

In May, Cox called on Congress to kill 28(e) because it involves "substantial conflicts of interest, may contribute to higher brokerage costs, is difficult to administer, and may operate to impede the further development of efficient markets." And in a speech he gave to the National Italian-American Foundation that month, Cox called soft dollars "as out of date as the Betamax, leisure suits, and [the 70's television program] Welcome Back Kotter.'" And, he added, they "offer perverse incentives to investment advisers to use them in ways that aren't beneficial to investors."

Only Congress can dismantle the provision, Cox said at the July Senate hearing. With the release of any disclosure rules, the SEC will have gone as far as it can, he added. Cox's tone at the hearing was conciliatory though, when telling Schumer he had no specific legislative recommendations for Congress. That was in contrast to his May letter when Cox offered to "submit legislative language to address this issue."

Cox's posture before the Senate echoed his June testimony before the House Financial Services Committee. There, he told lawmakers his recommendations were his own and not those of the SEC. "The Commission, as a group," Cox said, "is focused on rationalizing to the maximum extent that we can, the statutory scheme that we're administering." Jim Hamilton, a legal analyst with CCH, part of Wolters Kluwer, says Cox has "moderated his tone" since speaking to the Italian-American group. "The language was very strong in May," Hamilton said. Cox's May letter alarmed the industry. With the exception of the Investment Company Institute, which represents some of the largest mutual funds, most of the industry is opposed to the outright elimination of soft dollars.

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