Soft-dollar ban would threaten independent research firms

WASHINGTON — Up to 70% of independent research firms would consider exiting the business if the Securities and Exchange Commission bans investment management firms from using soft dollars to pay for research, according to a new study.

Already, uncertainty over soft-dollar regulation has cast a pall over the independent research industry, with many independent research firms either postponing adding staff or laying off workers, according to the study by Investorside Research Association, Washington, a trade group of 75 independent research firms.

"Contrary to conventional wisdom, all is not well in independent research land," said Scott Cleland, a co-founder and director of Investorside and chief investment officer of Precursor Group, a Washington-based independent research firm.

The survey, conducted during the first three weeks of August, found 95% of respondents reported being negatively affected by the soft-dollar "chill" and that 81% reported at least some of their mutual fund clients had moved to hard dollars.

Typically, mutual funds and other institutional investors have used soft dollars — or credits for trading commissions — to pay for research. Independent research firms argue that institutional investors have banned the use of soft dollars for independent research but not for proprietary research from Wall Street firms.

"What investors don't need is a continuation of the hidden, subterranean bundled commissions that have encouraged abuse in the past because it was impossible to oversee or audit who was paying for what in the undisclosed pool of trading commissions," said John Eade, chairman of Investorside and president of Argus Research Group, New York, in a news release announcing the survey results. "We support the SEC in requiring transparency from all research providers — independent and full-service investment banking brokerages — so that investors can see where their commission dollars are going."

Members of Investorside have recently met with SEC commissioners and SEC staff on the commission's soft-dollar task force to deliver the survey's findings and relay the association's concerns about a ban on soft dollars.

In a Sept. 9 statement, SEC Chairman William Donaldson said that inhibiting the access of investors to third-party research would be a mistake.

In a Sept. 3 letter to Mr. Donaldson, Messrs. Cleland and Eade, along with Investorside directors Stanton Green, who is president of Vista Research LLC, New York, and Lisa Shallet, chairman and chief executive officer of Sanford C. Bernstein & Co. LLC, New York, made three recommendations for soft-dollar regulation:

• Have the soft-dollar task force complete its work by Sept. 30 "to lift the regulatory uncertainty, which is stifling the investment research business and independent research in particular";

• Increase communication to ensure SEC personnel do not discriminate against third-party research in favor of proprietary research, that mutual fund company policies banning the use of soft dollars for independent research "will not result in more favorable regulatory or enforcement treatment" and is not best practice and that the SEC continues to support the existing regulatory definition of soft dollars and will "soon" redefine research and mandate the disclosure of all commissions; and

• Require transparency, accountability and an audit trail for soft dollars by mandating separate accounting of trading, research, banking and other commissions.

"We are confident the SEC will do the right thing for investors and that they understand the importance of independent research to investor protection," Mr. Cleland said in an interview.