Sunshine is often the best disinfectant. Roaches flee from it; germs die in it. Soft-dollar arrangements need more sunshine, more disclosure. It will disinfect them.
Soft-dollar arrangements - the direction of trading activity to specific brokerage firms in return for products and services - can be useful. Some institutions find it difficult to get the budgets to pay for research or consulting or other needed services.
But often part of the soft dollars generated by that trading activity is used not for the benefit of the originating institution, but for the benefit of one of its investment management organizations.
And often the soft dollars buy, not research or consulting, but other non-germane products or services.
Recent audits of 75 brokers by the Securities and Exchange Commission found, according to a report in Pensions & Investments, some one-third paid for money managers' expenses for rents, travel, salaries, postage, parking, furniture, college tuition and even a wedding with commission-generated soft dollars.
Money managers under the rules can use their soft-dollar credits for non-investment research purposes so long as they disclose it to their clients. But disclosure of soft-dollar arrangements is remarkably inadequate for such a huge business. A Greenwich Associates Inc. study last year estimated soft dollars accounted for close to $1 billion out of $6.6 billion in commissions annually, and were growing.
Douglas J. Scheidt, associate director and chief counsel in the SEC's investment management division, noted in the recent P&I report, "We've seen no disclosure, woeful disclosure or false disclosure" of soft-dollar arrangements by money managers.
The SEC now may get tougher with advisers, including mutual funds, according to Barry B. Barbash, director of the SEC investment management division. It should. Speaking before the ERISA Advisory Council of the Department of Labor, Mr. Barbash suggested requiring more detailed disclosure on form ADV money managers must file with the SEC. Pension funds and other money management clients should support it. The SEC should demand better disclosure and back it up by budgeting for increased monitoring and enforcement.
The alternatives are the status quo or a complete prohibition, neither of which is a desirable solution. The status quo would lead to firms continuing to take advantage of lax rules or monitoring; a prohibition would unfairly limit a money management firm and its clients. The Greenwich survey found 71% of institutions use soft dollars, up from 60% in the previous four years.
With detailed disclosure, which would reveal such unseemly uses of soft dollars as payments for weddings and college tuition, clients could decide whether or not to use a money manager with such disregard for the supposed purpose of soft dollars, that is, for investment research for the benefit of the client.
Many money managers and fund sponsors eschew the use of soft dollars out of concern about its possible adverse impact on the execution of a trade and, ultimately, on portfolio performance.
But for those unconvinced of the possible impact of soft dollars on performance, SEC mandated disclosure should help eliminate inappropriate use of those soft dollars.
The SEC should toughen disclosure and enforcement, and do so soon.