The term “soft dollars” refers to the use by investment fund managers—and the brokers with whom they deal—of that portion of the commission payments that exceeds the cost of executing the trade to acquire goods and services that benefit their managed accounts. The term also extends to the commissions paid on portfolio transactions that investment fund managers direct to brokers to induce them to sell their managed funds and/or to refer clients to them: a practice that is prohibited in some jurisdictions.
Some people view “soft dollars” as the industry’s dirty little secret and feel they should be banned. Others believe there are benefits to be gained by client portfolios that permit commission dollars to be used to acquire certain goods and services (such as research and investment-decision making tools)that enhance the ability of the money manager and the broker to identify investment opportunities and improve the portfolio’s return.
The issue of the appropriate use of commission dollars has been around for years and has been the subject of extensive regulatory and industry review. As a result, a lot of questionable practices regarding this use were eliminated. However, in recent years, the need to revisit the subject has arisen and regulators in the United States, the United Kingdom and Canada are currently reviewing the matter.
The Canadian Securities Administrators have issued a concept paper on the subject and have invited comments on it until May 6, 2005. They have stated that based on the feedback they receive, they will consider their next steps.
In the United Kingdom, the Financial Services Authority has issued a consultation paper on bundled brokerage and soft commission arrangements along with proposed rules. These rules address the identified lack of transparency and accountability and contemplate an industry-led solution based on enhancing the disclosure regime and limiting the use of commissions to the purchase of “execution” and “research” services.
The U.S. Securities and Exchange Commission is expected to issue its proposals by mid-year. These too are expected to focus on increased transparency and accountability, a possible narrowing of the definition of soft dollars and unbundling commissions by placing separate values on proprietary research, execution and capital commitment.
Good governance requires plan sponsors to understand the issues relating to the use of commission dollars, the proposed regulatory approaches, and the impact on their portfolios and on the continuance of competitive capital markets. It is important that there be a meaningful, industry-led dialogue on this to ensure that the right framework is in place that will foster investment decision-making based on independent research—rather than a focus on lowest costs. Perhaps it’s time to re-convene the 1995 Roundtable of Institutional Investors whose deliberations eliminated much of the controversy which then surrounded soft dollar use.
Glorianne Stromberg is the author of three reports on regulatory strategies, a securities lawyer and a former commissioner of the Ontario Securities Commission. email@example.com.
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