Wednesday, August 1, 2007
There was a recent article from the Wall Street Letter (subscription required) highlighting activism by the Securities Traders Association and the Alliance in Support of Independent Research on behalf of soft dollars as a response to SEC Chairman Cox’s personal comments in the WSJ in May against the practice and it caused me to rethink about my own views on the subject.
The whole concept of “soft dollars” is unique to the money management industry. As an investor, I know that I get charged management fees as a result of my relationship with an investment firm – seems fair given that I am receiving a service. These fees are supposed to cover the firm’s operational costs to manage my money – including the purchase of research. But firms then use soft dollars as additional currency for research on top of my fees. So how do I know that I am not paying too much in management fees since I can’t see the soft dollar benefit? I think Chairman Cox’s previous sentiments get to the root of this problem for the typical investor.
As a CEO of a company serving the buy-side, I clearly see the benefits of soft dollars. FirstRain is a research service; according to the SEC (we double checked this with our attorneys) it is fully acceptable to use soft dollars to pay for our services. And many of our clients do – regardless of assets managed, hedge fund or mutual fund. In addition to the large names like Pioneer, we have a growing number of smaller investment firms that see FirstRain as an extension of their research process – as a way to compete with larger firms that have more money and resource available to them.Soft dollars are able to help level the playing field for them. And for FirstRain, as a small emerging alternative research firm, we are able to get paid more quickly through our relationships with the broker-dealers than if we had to wait for direct payment. I should add that some of our clients who are the largest institutions use hard dollars to pay us.
So how can there be a win-win-win for investors, the buy-side, and research providers with regards to soft dollars? I think the solution is transparency. This is what the FSA decided in a U.K. ruling in late 2005 and it would make sense here in the U.S. The buy-side needs to tell their clients how their management fees are used and where the soft dollars are going and to do this the broker-dealers just need to disclose to the buy-side the break down of what comprises the “commission” so the buy-side can pass along this information to their clients.
Maybe it’s more complicated than this but it seems that if we all followed the spirit of why soft dollars were approved in the first place, and we gave investors transparency as to how their fees are being used, we all can continue to benefit from the soft dollar mechanism. If you have further interest in this topic, my friend Sandy Bragg at Integrity Research Associates and his colleagues regularly blog on this issue.