SEC likely to bypass soft dollar, brokerage reforms

The SEC will be taking a close look at soft-dollar and directed brokerage practices at mutual funds during the next six weeks, but industry participants do not expect major reforms anytime soon.

"Transparency of fees is more on their minds and market timing is more on their minds" than soft dollars and directed brokerage, said Theodore Eichenlaub, a former SEC official and founder of Adviser Compliance Associates, a manager consulting firm in Washington.

On Dec. 3, the Securities and Exchange Commission issued rules designed to end late trading and force more disclosure on funds' market-timing policies. The commission also set a short timetable to issue additional rules on fee disclosure and other fund policies.

Despite the heavy focus on late trading and market timing, soft dollars and directed brokerage are on the SEC's radar screen."I think it's something that they're definitely entertaining," mainly because of pressure from Congress, Mr. Eichenlaub said.

On Nov. 19, the House of Representatives passed legislation sponsored by Rep. Richard H. Baker, R-La., that would require registered investment advisers who manage mutual funds to submit reports annually to the fund boards on revenue-sharing, directed brokerage and soft-dollar arrangements. The bill also would require the SEC to study the issue.

Lee A. Pickard, a partner at Washington law firm Pickard and Djinis, who represents the Alliance in Support of Independent Research, said given this legislation, he expects the SEC to do the study on soft dollars but little else.

"My own crystal ball says that nothing will happen immediately because if a congressional group is asking the SEC to do a study, I don't know that they would do anything before then," he said.

David Tittsworth, executive director of the Investment Counsel Association of America, Washington, noted market-timing and late trading were consuming the bulk of the SEC's time. "It's obviously eating up all their resources."

John Nestor, an SEC spokesman, said the commission plans to issue in January new guidelines for mutual fund confirmation statements that "potentially will have explanation of soft-dollar arrangements."

But he added that the SEC set out some soft-dollar guidelines in its 1998 "sweep" report, and "I haven't heard anything about revisiting that guidance."

Soft-dollar arrangements allow an investment manager to receive credits for directing trading to a broker. Those credits, or soft dollars, typically are used to acquire research reports, news services and pricing services but also can be used for computer-related purchases and other similar purchases.

Under traditional directed brokerage arrangements, mutual fund complexes pay a fee — most often by directing their brokerage business — to a broker-dealer in return for fund distribution. Directed brokerage is permitted as long as the fund gets best execution for its buy and sell orders. The other form of directed brokerage is when a plan sponsor sends brokerage business to certain broker dealers in return for services, expenses or rebates.

"It's something that's very much on the minds of commissioners," Mr. Nestor said. "I imagine there will be something fairly explicit in the rule-making proposal to say precisely what financial arrangements should be disclosed."

Ahead of any potential SEC action, some mutual fund complexes, including MFS Investment Management and Putnam Investments, both of Boston, reportedly have ended directed brokerage practices.

MFS spokesman John Reilly declined to comment. Putnam Chairman John A. Hill, in a letter to SEC Chairman William Donaldson, said that beginning Jan. 1 the company will bar its advisers from considering sales of fund shares in allocating brokerage business. "We believe that eliminating this long-standing potential conflict of interest in the mutual fund industry would serve the interests of all mutual fund shareholders and urge the commission to make Putnam's new policy the industry standard," Mr. Hill said in the letter.

Mercer Bullard, founder and chief executive of Fund Democracy Inc., an Oxford, Miss., fund shareholder advocacy group, said that although he expects more mutual fund companies to follow the lead of Putnam, he doubts it will lead to a voluntary industrywide ban on directed brokerage.

But Eric Jacobson, senior analyst at fund research firm Morningstar Inc., Chicago, said the scandals rocking the mutual fund industry might push more fund complexes to discontinue directed brokerage.

"In today's environment I would say optimistically that there may be enough momentum," he said. "A lot of fund companies are very anxious about the scandals we're going through and they recognize that if they don't get ahead of some of these issues, it's going to be like waiting for the other shoe to drop.

"A lot of institutional investors have the clout to do better due diligence," he said. "My hope is, especially now that a lot of these issues are on the table, you'll find more pension consultants and large pension plans holding a lot of investment advisers' feet to the fire."