Pension fund executives welcome the SEC's plan to require money managers to give clients detailed information on their "soft dollar" arrangements with brokerage firms.
The Securities and Exchange Commission also might ask banks that manage money for pension funds and other institutions to provide the same information to their clients.
In soft-dollar arrangements, money managers receive commission rebates from securities firms to which they direct trades. Such rebates are not paid in cash, but can be used by money managers or pension plan sponsors to buy research services directly from the brokerage firms, or from outside research houses.
Securities laws allow money managers to choose brokers taking higher commissions than others so long as they can the prove the securities firms provide better service and research.
"It's a good first step," said William F. Quinn, president of the $6.9 billion AMR Investment Services Inc., Fort Worth, Texas. AMR oversees the investment management of American Airlines' pension assets. "But it still allows or encourages money managers to pay for expenses (with clients' money) that they should be paying for on their own," said Mr. Quinn, who would like the SEC eliminate the practice.
But Lee Pickard, partner at the Washington law firm of Pickard and Djinis, condemned the agency's plans. "The SEC should have the courage to pause and see that additional disclosure is not required," said Mr. Pickard, who represents a group of soft-dollar brokerage firms and outside research firms that thrive on business paid for through brokerage commission rebates.
Under securities rules, money managers already must give their clients an annual written explanation of their choice of brokerage firms, and comment on the rate of brokerage commissions they pay. If the commissions are higher than those charged by other brokers, money managers must explain if there are benefits from using those brokerage firms that offset the higher commissions.
The treatment of soft dollars was among the many recommendations made by the SEC's division of market regulation in its Market 2000 report, released late last month. The report was the first comprehensive study of the nation's equity markets in more than 20 years.
Meanwhile, some operators of privately run computerized trading systems expressed fears they could lose customers to the stock exchanges if the SEC adopts the report's recommendation that customer orders for certain securities be displayed and available for trading on all of the different exchanges and trading systems.
Such privately run computerized trading systems, some of which are dealer-operated or run as stock exchanges of a sort, all compete for institutional investors' trades with the New York Stock Exchange, the Nasdaq Stock Market, and other traditional exchanges.
"Our customers would not use the call market (the fixed-time trading systems) that required their orders to sit there and be vulnerable to dealers picking them off while they wait for the call," said Steve Wunsch, president of AZX Inc., New York, which operates the Arizona Stock Exchange in Phoenix. The Arizona exchange is regulated as a privately run computerized trading system rather than as an exchange because of its low volume. "If the order exposure rule led to such a situation, the benefits of call markets for customers would be eliminated."
Securities trades on the New York Stock Exchange are executed all day at varying prices through specialists who deal in specific stocks. Mr. Wunsch said it may be cheaper for institutional investors, who don't need to buy and sell securities immediately, to trade through AZX, which has no dealers, and executes trades at one price, at one time, an hour after the Big Board closes.
But Junius W. Peake, a professor of finance at the University of Northern Colorado in Greeley and an expert on securities matters, said it is too soon to say who will lose out.
"The system that is going to evolve, if the SEC does its job right is the one that provides the best execution at the lowest transaction costs," said Mr. Peake, a former Nasdaq vice chairman.
The SEC had proposed such an order exposure rule in 1982, but subsequently abandoned it. The New York Stock Exchange, which over the years has lost business to the less expensive, privately run computerized trading systems, has been pushing for such a rule. The U.S. General Accounting Office also recommended such a rule.
In the first six months of 1993 alone, such off-exchange trading systems traded 4.7 billion shares, just less than the 4.9 billion traded the previous year. But the 1993 volume represents just 1.4% of the volume of the Big Board, and 13% of the total volume in the NASDAQ and over-the-counter stocks, according to the Market 2000 report.
The Market 2000 report recommended the NYSE and other exchanges write such a rule for the SEC's consideration.
At the same time, the report yielded to privately run computerized systems, and recommended they continue to be treated as brokers, rather than as stock exchanges, as the NYSE, Nasdaq and other exchanges had wanted. The SEC will require, however, such off-exchange systems to provide records of securities trades and reports of their operations, a move the private trading systems do not object to, Mr. Wunsch said.
The SEC is expected to formally propose, as rules, the report's recommendations on soft dollars and privately run computerized trading systems within the next few months, said Brandon Becker, head of the market regulation division.
The agency's plans to propose a rule on soft dollars follow a confidential report it published on the matter last December, after SEC officials met with representatives of brokerage firms that rebate commissions to money managers, independent research houses that get paid through such soft dollars, and some of the nation's largest corporate pension funds.
Under the Market 2000 report's recommendation on soft dollars, money managers would have to disclose to pension funds and other large investors total brokerage commissions paid from their accounts for all securities trades, as well as to brokerage firms that rebate commissions. Money managers also would have to spell out the costs of research and other services bought from brokers and outside research firms with soft dollars.
"If we get the kind of common-sense disclosures that enable people to understand how soft dollars are being used, people will be happy," said Fred G. Weiss, who manages the $1.2 billion pension plan of Warner-Lambert Co., Morris Plains, N.J. Some of the pension plan's money managers accept soft dollar research, he said.
But, defining soft-dollar research may be difficult, he acknowledged.
The disclosures money managers would have to make to pension funds would be similar to those suggested last year by executives from Morgan Stanley & Co. and Goldman Sachs & Co., with one exception. The full-service securities firms also would have to reveal some of the costs of the research they provide money managers in exchange for commission rebates.
In congressional hearings last summer, Anson Beard Jr., managing director at Morgan Stanley, and David Silfen, partner at Goldman Sachs, had proposed discount brokerage firms break out the cost of outside research provided to money managers, but argued it was difficult for full-service brokerage firms to do the same.
The SEC proposal on soft dollars, which has been expected for some time, should allay fears that money managers might be directing securities trades to brokerage firms that offer commission rebates, rather than to those that offer the best execution of trades. The SEC proposal also should alleviate concerns that money managers might be using these commission rebates to buy products and services that benefit them rather than their institutional clients.
"The problem, in a nutshell, is when you're spending other peoples' money, you're awfully tempted to buy stuff you might not buy for yourself," said a government official who preferred not to be identified.
In a report published last year, Greenwich Associates estimated money managers directed one-third in listed commissions on equity trades to brokerage firms, or a projected $600 million in 1993. At the time, the Greenwich, Conn.-based consulting firm predicted total soft dollar commissions, including those directed by pension plan administrators to brokerage firms, would approximate $1 billion in 1993.