Soft-Dollar Bill on the Horizon

Soft-dollar brokers, start your lobbyists. Capitol Hill lawmakers, emboldened by a letter to two committees from Securities and Exchange Commission chairman Christopher Cox, will debate soft-dollar legislation this session.

That’s according to several Congressional staffers who said at least one bill would be introduced this session that would tighten or possibly end the use of these controversial alternative commission arrangements.

“The senator is very interested in this issue and wants soft dollars better disclosed,” said a Senate staffer who declined to be quoted by name or to identify his boss. The staffer promised that the senator would introduce a bill this year.

The Senate staffer said his boss would consider a bill that would either abolish soft dollars or at least require all trading costs be included in the expense fund ratio. Today, a fund’s expense ratio is in the prospectus, but the brokerage commission charges are not included. Commissions are separately listed in the statement of additional information-and, as the staffer put it: “Who reads the statement of additional information?”

Soft-dollar brokerage is a practice that allows money managers to pay higher-than-usual brokerage costs in exchange for research services.

The practice, made legal by Congress in 1975 with Section 28(e) of the Securities Act of 1934, has been the focus of much handwringing in recent years, as soft-dollar supporters and foes clashed in Washington.

Most of the industry believed the issue was settled by an SEC “interpretative release” last July, but Cox surprised the industry when he called on both the Senate Banking and House Financial Services committees to either “repeal or substantially revise Section 28(e).”

In his letter, Cox found four faults with the use of soft dollars: they may create conflicts of interest between money managers and their clients; they may contribute to higher brokerage costs; they are difficult to administer; and they impede the development of efficient markets.

Cox is raising the issue at a propitious time. Democrats-several of whom unsuccessfully tried to pass soft-dollar reforms last year, when the GOP was in charge of Congress-now control Congress and the key committees where such a reform bill would likely originate.

Among the Democrats who would likely be key players in any debate are House Financial Services Committee chairman Barney Frank, D-Ma., and Senate Banking Committee chairman Christopher Dodd, D-Conn.

Another key player is Charles Schumer, D-N.Y., a member of the Senate Banking Committee. He has had close ties to the securities industry, and in the past has opposed the abolition of soft dollars, arguing it would “hurt the small guy.”

With Sen. John Sununu, R-N.H., also a member of the Senate Banking Committee, Schumer sent a letter to the SEC last year stating, “without commissions supporting research, the investment public would be greatly disadvantaged.”

Spokespeople for all of these members of Congress have been contacted, but none would publicly comment. Another soft-dollar player will be Senate Banking Committee member Daniel Kahikina Akaka, D-Hawaii.

Akaka is a soft-dollar critic. He authored an effort to reform soft dollars, the Mutual Fund Transparency Act of 2005, which would have required greater disclosure. It died in the last session.

However, late last year Akaka said the measure would be renewed if the Democrats took control of Congress. (See Traders Magazine, October 2006.) This has spooked some lobbyists for the securities industry, who in previous years have been able to ensure that soft dollars were not regulated or legislated out of existence. They believe the industry isn’t watching the issue closely this time.

“What I’m worried about is that the securities industry isn’t taking this seriously,” said David Franasiak, an attorney with the Washington firm Williams & Jensen. He represents several securities industry groups.

Still, one industry observer agreed that there would be legislation on soft dollars, but said radical change is unlikely.

“I think it is likely that Congress will require some more disclosure,” said Michael Mayhew, founder of Integrity Research Associates, “but I don’t think they will abolish [soft dollars].”

Mayhew contended that soft-dollar supporters would argue that the small investor would be hurt by the end of soft dollars. “They will say that hedge funds are not affected by these rules. They can use soft dollars, but the guy in the average mutual fund won’t have that option. That’s not fair,” Mayhew said.

At press time, the House Financial Services Committee was due to meet with all five SEC commissioners to review investor protection issues. The committee is headed by Rep. Frank, who has been critical of soft dollars in the past.

A committee staffer predicted that soft dollars “would certainly come up.”

STA Says Save Soft Dollars

The Security Traders Association, disagreeing with Securities and Exchange Commission chairman Christopher Cox’s recent letter criticizing soft dollars, recently urged members to lobby Congress and save the practice.

Cox recently called soft dollars “troubling” and said they are designed to inflate commissions paid by individual investors. But STA president and CEO John Giesea countered that these alternate commission arrangements “actually lessen conflicts of interest.”

That’s because soft dollar credits, which are earned by paying higher than the cheapest commissions, provide access to research for smaller money managers, according to the STA.

Giesea said the STA doesn’t oppose more soft dollar disclosure rules, which it expects from the SEC. However, he said, it opposes any legislation that would end soft dollars.

Gregory Bresiger

Buyside Wants Intervention

The latest storm over soft dollars makes the headlines just as a new study indicates the buyside wants regulators to step up to the commission plate.

According to Greenwich Associates, more than 60 percent of money managers and two-thirds of plan sponsors say they “favor regulatory intervention that would help clarify what needs to be disclosed regarding commissions paid to equity brokers.”

The Securities and Exchange Commission has previously vowed to produce guidance regarding disclosure, but has yet to release anything.

Peter Chapman