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Greenwich: with Eye on SEC, Institutions Lighten Soft Dollar Use

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GREENWICH, Conn. (–Research Research by Greenwich Associates, Inc. shows that institutional investors have reduced their use of soft-dollar commissions to purchase third-party research and services over the last year as the investors await the outcome of deliberations within the Securities and Exchange Commission.

In the first quarter of 2005, institutions used an estimated US$1.13 billion of “soft” money for such purposes, down from US$1.25 billion in the first quarter 2004, roughly a 10% decline.

“U.S. institutions are clearly adopting a more conservative approach” to this issue, says Greenwich Associates consultant Jay Bennett, in the report. He also noted that the SEC’s review “has taken longer than many investors had anticipated.”

The report was based on interviews with decision makers in 400 U.S. institutions investing in U.S. equities. It finds that although these institutions have cut back their use of soft dollars, they haven’t cut back as severely as they thought they would a year ago.

With regard to hedge funds specifically, the report finds that only about 55% now acknowledge using soft dollars – that number was 90% two years ago. But the report also reminds its readers that statements from such institutions about the non-use of soft dollars have to be “parsed carefully,” since the phrase means different things to different decision makers.

Hard dollars are those paid to a broker-dealer as part of an agreed-upon cash transaction. Soft dollars, as generally defined, are those paid for services, beyond trade execution, with the commission–which results in a commission that is higher than it needs to be, according to critics, who also say soft dollars harm transparency, lead to conflicts of interest, and saddle investors with costs that management should bear.

Because soft dollars are commonly used to pay for research, the SEC task force is considering whether a carefully drawn definition of “research” would lessen conflicts of interest between managers and investors. As the Greenwich Associates report observes, a consensus has formed in the marketplace that certain services are appropriate for soft-dollar payments, such as access to financial market quotes; third-party research produced by vendors and non-broker dealers, financial databases; and third-party research produced by independent boutiques. There is also consensus that certain services (such as news subscriptions and publications) ought to be paid for with hard dollars.

In 1975, the U.S. Congress enacted a safe harbor provision so that no person who “exercises investment discretion with respect to an account” shall be deemed to have violated fiduciary obligations solely “by reason of his having caused the account to pay more than the lowest available commission if such person determines in good faith that the amount of the commission is reasonable in relation to the value of the brokerage and research services provided.”

Contact Bob Keane with questions or comments at: [email protected].


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