The investment management industry's new proposed soft-dollar standards are a step in the right direction, say industry sources who have reviewed them.
But sources say the proposals fall short of expectations because they request, but don't demand, that money managers reveal all details of their soft-dollar relationships with brokerage firms.
The standards proposed by the Charlottesville, Va.-based Association for Investment Management and Research clarify the scope of such arrangements, in which money managers receive in-kind rebates rather than cash discounts on commissions from brokerage firms in return for trading securities through them.
Securities and federal pension laws permit money managers to pay brokerage firms higher than the prevailing rate of commissions as long as they receive investment research in exchange.
The standards expand the definition of soft-dollar arrangements to include in-house research provided by large Wall Street firms to money managers in exchange for securities bought and sold through them. Traditionally, soft-dollar arrangements referred only to research provided by independent or "third-party" research firms.
AIMR's proposal also expands the meaning of soft-dollar trades to include those without commissions - such as fixed-income trades or those over the Nasdaq Stock Market. The Nasdaq Stock Market is a dealer market in which brokers make money on the spreads between bids and asked prices, rather than by charging flat fees per share.
What's more, the AIMR proposal clarifies that research purchased with soft dollars is acceptable only if it helps the money manager in making investment decisions, not in managing the firm.
Finally, the proposal requires money managers to tell clients that they participate in soft-dollar arrangements before they set up such arrangements using the investors' commission dollars, and to inform investors that they can get additional information about soft-dollar arrangements on request.
The standards are the investment management industry's attempt at self-policing aimed at pre-empting regulatory action by the Securities and Exchange Commission.
Easier comparisons
"One of the things I like is the standards make sure everyone presents information the same (way) so you can compare apples to apples and oranges to oranges," said Mony Rueven, senior vice president at D.E. Shaw Securities L.P., a New York-based soft dollar brokerage firm.
And Theodore R. Aronson, head of the Philadelphia-based Aronson + Partners, called the proposed standards "real, real good."
At the same time, Douglas J. Scheidt, chief counsel in the SEC's investment management division, said the standards are "good in providing useful information to the industry - standards that are higher than the minimum required by law."
And Jeffrey Duncan, legislative director to Rep. Edward J. Markey, D-Mass., who has held hearings on soft dollars and has a long-standing interest in the practice, said that while the standards are useful, they are not a substitute for SEC guidance.
"The problem with voluntary standards is that the people who are more likely to comply with them are the people less likely to get into problems in the first place, and the people likely to get into trouble don't sign up," Mr. Duncan said.
And Mr. Aronson expressed disappointment that money managers don't have to disclose specifics of the research purchased through soft-dollars unless clients specifically ask for that information.
When clients ask for more information, money managers would be required to provide descriptions of the research products and services they have received through soft dollars, identify suppliers of products and services, and disclose the total commissions paid from a client's account to each broker.
Not everyone wants it
Michael S. Caccese, AIMR's general counsel, said the standards do not require money managers to provide details of their soft-dollar arrangements as a routine matter because some investors don't want that information.
But that argument doesn't fly with Mr. Duncan.
"They could have always structured it as a default - providing that information unless the client specifically says 'don't provide it', " he said.
Many investors, he said, might not know what to ask for. And asking investment advisers to provide additional information about their soft-dollar arrangements might suggest a lack of trust in the money managers, he said.
Moreover, a plan sponsor, who declined to be identified, found the standards lacking in their failure to discuss the practice of sequencing trades, in which directed trades are executed by brokerage firms after non-directed trades and thus don't get as good a price.
Mr. Aronson said the problem of sequencing is particularly acute among managers that handle both wrap and non-wrap accounts.
"If you have wrap business and non-wrap business, what do you do first?" he asked.
But Mr. Caccese noted that the AIMR report, which will be considered by the board after the Feb. 28 end of a 60-day comment period, addresses that issue in a limited way by reiterating money managers' obligation to obtain "best execution." The report defines best execution as trades that result in a client's total cost being "the most favorable under the particular circumstances at that time."
The group hopes to address best execution in greater detail later, Mr. Caccese said.
'Very complicated'
Meanwhile, Harold Bradley, head of equity trading at American Century Investment Management Inc. in Kansas City, Mo., and a vociferous critic of soft-dollar practices, gave AIMR "credit for additional disclosure" beyond that required by the SEC but called the disclosure requirements for money managers very complicated.
"I'm not sure how we would implement them," he said.
And he said the disclosures are incomplete because they do not ask money managers to put a price tag on the research products and services they receive through soft-dollar arrangements.
For years, the big Wall Street firms have said they cannot break out the cost of research reports, or of access to securities analysts, for example, that they routinely give to money managers who trade through them.
"I'm sure there's a way to figure it out. Firms, for their own internal purposes, have to know," Mr. Duncan said.
Moreover, Mr. Bradley said he could not understand the logic of AIMR's proposed expansion of soft-dollar trades to include principal trades.
"The basis of the reasoning in this report that there is no difference between agency and a principal trade - that every trade has a research component - I find untenable," Mr. Bradley said. "Not every trade has a research component."
Others disagreed.
The expansion of the definition of soft-dollar arrangements to include non-commission trades was simply an acknowledgement, "that principal and bond trades also carry research possibilities with them, and that the managers use the selection of the broker to get the research that they need," said Wayne H. Wagner, president of The Plexus Group, the Los Angeles-based performance measurement firm. Mr. Wagner was a member of the AIMR committee that developed the soft-dollar standards.
