The use of Commission Sharing Agreements and Client Commission Agreements, otherwise known as “soft-dollar” arrangements, benefit institutional investors and brokers more than the underlying investor.
That’s the finding of areport from Woodbine Associates. The study, “Soft Dollars and Bundled Services: Practices, History, and Controversy,” examines both CSAs and CCAs in its review of “soft-dollar” programs used by participants to pay for research, using trading commissions from their activity in U.S. equity markets.
These agreements benefit money managers and brokers but too often not underlying fund investors or retails investors, according to Matt Samelson, principal at Woodbine Associates and author of the report. They lack transparency in terms of what the underlying costs are for things such as research and trading costs.
“The world is crying for transparency, yet there is no movement toward a truly unbundled world,” Samelson said. “Why is that?”
There is no legal or moral incentive to provide transparency as there is nothing officially or intentionally being done wrong, he said.. The value of research is often guesstimated, not assigned a hard dollar value by the brokers.
Since this has been the way the Street has done business since the 1700s, it has become standard practice and acceptable, Woddbine contends. And for the most part it has worked.
Usage of CSAs and CCAs has made payment of research chits easy for the brokers and money managers and they tout savings as the reason for using them. Recent research from Greenwich Associates said the usage of CSAs is on the rise.
Woodbine’s report doesn’t call for end of CSA usage, but wants to shed light on an opaque practice and argued more savings for the pension fund saver or mutual fund investor can be had if brokers actually assigned a hard-dollar mount to the value of their research and made that known.
“There is no political will among legislators to demand from brokers or the buyside what are the true costs or research and that those costs are clearly stated,” Samelson said. “These services are valued without any continuous guidance from regulators as to what and what doesn’t constitute eligible broker services in the CSA. A lot of discretion is left to the money managers and how it benefits their investment decisions.”
As an example, Samelson pointed to proprietary research. If a money manager is paying for research through broker, that manager might agree to pay four cents a share per trade for execution and research services. There is no actual breakdown between what the execution cost is and what the research cost is.
“These costs are not broken out or valued on a sophisticated basis. Rather, they are done on the back of a napkin,” he said. “They are often estimated.”
Brokers counter that CSAs or soft-dollar arrangements create operational efficiencies, improve the quality of research products and brokerage services by fostering competition, keep production costs down, and keep smaller entities in business that otherwise could not survive in an unbundled environment.
Samelson added that while fuzzy math seems to be the case here in valuing broker services in a bundled commission world, nothing outright devious or sinister is going on. No one, he said, is abusing investors intentionally, but that it does happen from time to time.
Samelson is not alone in arguing for more transparency. Politicians, academics, regulators, and particular money manager clients who highlight well-acknowledged conflicts of interest between money managers and their clients want more transparency. But there has been neither the political will nor regulator inclination to do much.
“U.S. regulators are effectively powerless to prohibit the use of soft dollar arrangements, if they were inclined to try, which they are not, since the practice is deeply rooted in securities legislation,” he said. “There is a lack of political will and industry desire to abandon soft dollar arrangements. They are likely to be part of the equity landscape for the foreseeable future.”
