How Will the SEC Rule on Soft Dollars?

With a decision on the use of soft dollars imminent, the industry ponders how the SEC will rule on the controversial issue. Securities and Exchange Commission Chairman William Donaldson has stated he would like to see parity between independent research and proprietary research. Some industry sources interpret "parity" to mean that the SEC would like independent research to compete on a level playing field with proprietary research.

While most observers say an outright ban on soft dollars is unlikely, restrictions are anticipated. "There is going to be a narrowing of the definition of what research really means," says Stephen Schardin, president of Charles River Brokerage, a brokerage subsidiary of Charles River Development that was set up in November 2004 so buy-side customers could pay for the Charles River order-management system with soft-dollars. Schardin adds that he believes the SEC is going to say certain items are not allowed under the research umbrella, such as a T1 line or a terminal, even if they are attached to a service with research value.

"The SEC hasn't given much color on what it will be doing, other than repeating that disclosure is going to be the cornerstone of what they're going to come out with," says John Meserve, president of independent research provider BNY JayWalk, a subsidiary of The Bank of New York.

Supporters of independent research have defended the practice, pointing out that soft dollars are fully disclosed. "The independent research part is already unbundled so the investment manager can see what is for execution and what is for research," says Meserve.

For example, if an investment manager talks to a third-party research firm and learns that it will cost $100,000 a year to talk to its analyst and is told it will cost $140,000 in commission dollars to obtain the research from a soft-dollar broker, the extra $40,000 goes to execute, clear and settle the trade, and is effectively the profit margin for the broker-dealer doing the service, explains Meserve. "That level of detail was never required by regulators," he says.

With the demand for more transparency looming, eXGEN Securities, an institutional agency broker, is building tools for buy-side clients to access real-time reports on their soft-dollar transactions. "People who are paying for research are still paying four or five cents. In that case, we would be able to calculate a soft-research credit on those trades," says Brian O'Day, managing director at eXGEN. "We think it should be disclosed all the way through the process," he adds.

For more on soft dollars, stay tuned for WS&T's June cover story. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio