INDIANAPOLIS - Finding a good reason to use commission recapture and soft dollar programs isn't proving to be easy for officials of the Indiana Public Employees' Retirement Fund.
The $7.3 billion fund invested in equities for the first time in May, following voter approval last November.
As a result of its move into equities, fund officials are studying whether to participate in the directed brokerage practices of commission recapture and soft dollars.
H. Garth Dickey, executive director, said he doesn't see the logic behind using directed brokerage.
"We know that it's legal, the question is, are we really comfortable with how it works?" Mr. Dickey said.
Mr. Dickey said he recognizes a small fund like his is not likely to change the way things are done were it to not authorize soft dollar or commission recapture for its fund.
But he thinks the Council of Institutional Investors, Washington - known for its work in corporate governance - is the type of organization that could have an impact.
The CII has a great reputation, and has given more attention to plan governance issues recently, he said.
Some executives for plan sponsors in CII acknowledge and share Mr. Dickey's distaste for directed brokerage, but aren't anticipating big changes either.
"I frankly don't see it (directed brokerage) changing," said Tom Herndon, executive director of the Florida State Board of Administration, Tallahassee.
"As unpleasant as it is, and it is unpleasant, we will continue to use it. We can't leave money sitting on the table," Mr. Herndon said.
In fact, Florida is planning to begin a commission recapture program in the next few weeks, he said.
Likewise, Jon Lukomnik, deputy comptroller for pensions with the New York City Retirement Systems, said: "Soft dollars are an issue for virtually everyone" in the institutional investment community.
No one likes soft dollars, but they've become "an unfortunate fact of life," he said.
Nonetheless, "Garth is playing a valuable role in examining whether they have to be an unfortunate fact of life," Mr. Lukomnik said. He declined to speculate as to whether Mr. Dickey would be successful.
And directed brokerage foe Theodore R. Aronson, partner with money management firm Aronson + Partners, Philadelphia, said that while he still opposes directed brokerage, he has less hope than he used to have that the situation will ever change.
"Is what Garth's doing good? Absolutely. Will it have a great influence? I'm not so sure," he said.
Although they are often lumped together, Mr. Dickey views soft dollars and commission recapture as separate but related issues.
Soft dollars are brokerage commissions that can be used to pay for services such as research. A money management firm, for example, could pay for investment research by placing a trade with a specific broker.
Commission recapture typically involves placing trades with a specific broker, at the behest of a client pension fund, and having a portion of that commission rebated to the fund administration. Public funds are prime users of commission recapture.
Another related practice, called a step-out, is growing and further hides the true cost of trading, said Harold S. Bradley, vice president and director of equity trading for American Century Investment Management, Kansas City, Mo. A step-out involves directing a portion of a brokerage commission to a firm that doesn't have anything to do with the trade, but will either provide a service or rebate a portion of the commission, Mr. Bradley said. The beneficiary is the plan sponsor, he said.
Step-outs, along with soft dollars and commission recapture, are another sign that "everyone's forgetting it's the participant's money," Mr. Bradley said.
Mr. Dickey, who worked as a Wall Street investment banker before joining the Indiana fund in late 1995, said he believes the majority of soft dollar and commission recapture activity is done legitimately, but he would prefer more transparency in the process.
Regarding soft dollars, he said it is difficult to figure out who's really benefiting from soft dollars: the plan sponsor or the money manager spending the soft dollars on research.
"If we as institutional investors don't view brokerage policy as something we need to worry about, then we're giving money managers latitude to use commissions as they wish," he said.
"There are areas where the practices are abused," he said.
And while he acknowledges commission recapture can ease some of the financial burden of running a public pension fund, he said the practice doesn't make sense and inhibits good financial controls.
Where is the logic of charging a brokerage commission of, say, 6 cents a share, only to rebate half of it to the plan sponsor, Mr. Dickey said.
It's not necessarily a bad thing to do, but he asked whether governments really want to force pension funds to go outside of the budgetary process to gain the resources to do their jobs.
Mr. Dickey, like others, said he doesn't perceive expanded enforcement or regulation by the Securities and Exchange Commission as a solution. The SEC is very far into an investigation of soft dollar practices by money managers and reportedly has begun to crack down on abuses by selected managers.
Mr. Dickey suggests full disclosure by money managers and pension funds on how soft dollars and commission recapture dollars are spent would clear a way a lot of the abusive practices. "All I'm looking for is transparency and I want to be able to properly measure performance," he said.
If pension fund managers got together and required it of money managers, and themselves, change could occur, he said.
He said a committee of the CII will be meeting in early June to discuss what the organization will do regarding directed brokerage, if anything, with the results of a survey it is conducting on the topic.
Another group, the Association of Investment Management & Research, Charlottesville, Va., is conducting its own research into soft dollars.
"We plan on giving more guidance," said Jonathan J. Stokes, director of professional conduct for AIMR.
While soft dollars already are addressed in AIMR's code, he said AIMR officials decided to research the topic and write a specific report, given its relevance to its members, who are chartered financial analysts.
Meanwhile, the Indiana State Teachers' Retirement Fund, Indianapolis, is much less further in terms of getting a portion of its $3.6 billion invested in equities, and hasn't had to face the soft dollar/commission recapture question. Robert Newland, investment officer for the fund, said officials asked consultant, Callan Associates Inc., San Francisco, to make recommendations on how to handle directed brokerage, but no decision is expected until at least July.
And even Mr. Dickey acknowledges the Indiana Employees' fund might end up participating in soft dollar and commission recapture programs.
"As one $7 billion fund, we're not going to change the way the world works," he said.