SEC Has Done Softers a Favor

Consultant predicts greater use of soft dollars in future

SUMMIT, N.J. (HedgeWorld.com)--The president of a consulting firm that assists asset managers (for hedge funds and others) in tracking and optimizing the value of their soft-dollar commissions said July 13 that he believes the use of such commissions will expand in the years to come.

Robin Hodgkins heads Cogent Consulting LLC, founded in 1983, which helps managers "evaluate the value that they receive both from an execution and from a research point of view," he said. Mr. Hodgkins said he believes that Greenwich Associates was right when it estimated recently that close to 9% of total U.S. equity commissions are now part of soft-dollar arrangements. He said that this percentage will increase, "specifically because of the favor the Securities and Exchange Commission has now done for the industry," via the unanimous vote June 12 to approve an interpretive release on soft money.

He said that the SEC has now put its seal of approval on soft dollars as a legitimate way of paying for research.

Although in certain respects the interpretative release limits softing, Mr. Hodgkins said that the limits--such as a prohibition on paying for mass-marketing periodicals with brokerage commissions--are a small part of the big picture. Some asset managers might be tempted to argue that they make better decisions if they read Forbes regularly than if they don't. But, Mr. Hodgkins said, they might equally well argue that they couldn't do their job without electric lights. They don't pay the utility company through their brokerage commission.

Some of the charges that have been leveled at the use of soft dollars--such as its alleged use to pay for vacations in Bermuda--strikes Mr. Hodgkins as simply silly and trivializing.

The SEC's action July 12 came about two weeks after receipt of a letter from two Senators--Charles E. Schumer (D-N.Y.) and John Sununu (R-N.H.). (The two Senators signed this letter on June 7, but it wasn't stamped as delivered to the SEC until June 26.) Sens. Schumer and Sununu reminded the SEC that the proposed rule was issued in October 2005, and the comment period closed on Nov. 25, 2005.

The senators noted that during the three years that the SEC has been studying the issue of soft money, "many asset managers have reduced or eliminated research commissions as they wait for final guidance?? 1/2 ."

One argument often heard against soft dollars, and indeed against the existence of any legislative "safe harbor" for the practice at all, is that they are in essence opaque, and that they don't pay for anything that couldn't be purchased directly with a cash payment ("hard money") after the unbundling of trading-execution services from research. Tamar Frankel, a professor at Boston University School of Law, made this point as a commenter to the SEC.

"The current soft-dollar arrangements," Ms. Frankel wrote, "have created an inefficient barter market and a bundling of two essentially unrelated services. . . . Both results are inefficient and costly. I support the movement to separate the two services and ask the [SEC] to encourage separate payment for these services in cash."

Mr. Hodgkins said he disagrees with such reasoning. "The problem with hard dollars is that some research is peripheral to the day-to-day activity of an asset manager but it does have a corollary impact on investment decision making" over longer spans of time. For example, a particular manager might specialize in investments in the petroleum industry. In day-to-day terms, developments in agriculture may seem quite peripheral. But over time, given research into biofuels, the two industries may collide, and the manager will have been prepared for that if he had kept up on the agribusiness world. It is for that sort of research that soft dollars are more appropriate than hard, Mr. Hodgkins said.

Any ruling against soft dollars would amount to "unnecessary blinders" on those who make the portfolio decisions, to the detriment of their clients, the investing public, he said.

Cogent is the leading provider of software in the field, and this has been its primary focus over the last five years. More than 40 buy-side firms, with a total of more than $2 trillion in assets under management, use Cogent's solutions to evaluate soft dollar services from brokerage firms and third party vendors.

CFaille@HedgeWorld.com

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