Commentary: Take A Hard Look At Wall Street's Soft DollarsMichael Schroeder
Much of the recent Presidential campaign was paid for by so-called soft money--contributions that evaded campaign-financing laws. Wall Street has its own form of slippery, dubious currency, dubbed "soft dollars." When an investment manager at a mutual fund pays a brokerage house commissions to buy or sell securities, the firm in return will often send back soft dollars, in the form of such services as research, to the investment manager.
That may seem innocuous. But the arrangement, in effect, allows fund managers to use commissions, which are paid by investors, to buy research and other services that should be paid for by fund managers. Money managers often select brokers on the basis of who pays the largest soft-dollar rebates--instead of who offers the lowest brokerage rates or the most favorable trade execution. Stated less elegantly, fund managers are taking money out of investors' pockets. According to Greenwich Associates, at least $600 million in brokerage commissions spent annually by money managers is converted into soft dollars. Some money managers believe the total tops $1 billion.
The Securities & Exchange Commission, quite properly, is now taking a hard look at this practice. Says SEC Chairman Arthur Levitt Jr.: "The use of soft dollars troubles me because the interests of investment advisers can be put before [that of] their clients." In 1986, the SEC approved a "safe harbor" for anything that "assists [money managers] in the decision-making process." But many practices range far beyond that definition.
INFREQUENT AUDITS. To Lee A. Pickard, a lawyer representing the soft-dollar lobbying group Alliance in Support of Independent Research, the issue is much ado about nothing. Not only is the practice reasonable, but incidents of abuse are rare, he says, and SEC enforcement actions have been few and far between. Increased government scrutiny in the past few years, he adds, has caused advisers and funds to become more circumspect about accepting questionable soft-dollar services.
There are grounds to doubt that assessment. The SEC audits many investment advisers so infrequently--an average of once every eight or nine years--that the extent of improper payments easily may have gone undetected. "We hear of too many instances of bad practices. That makes this issue important to us," says Barry P. Barbash, director of the SEC's Division of Investment Management.
To determine the magnitude of abuse, the SEC undertook a massive review in mid-November, examining the books and practices of hundreds of brokers, dealers, investment managers, and mutual funds. It's too early to tell what the investigation is turning up.
The betting on the Street is that the SEC will find a load of smelly practices that fall outside the rules. These days, securities executives say, brokers often pay for such "research" services as rent, phone bills, and computer hardware. Harold S. Bradley, head trader at the Twentieth Century/Benham fund family in Kansas City, Mo., says he recently got a CD-ROM from Merrill Lynch & Co. promoting dozens of soft-dollar services, including a $200,000 trading system desk. Says a Merrill spokeswoman, "The products are consistent with the SEC guidelines."
A growing number of fund groups is starting to distance themselves from soft dollars. Twentieth Century was among the first to stop entering into soft-dollar arrangements about three years ago. Other groups have followed suit, including Scudder, Stevens & Clark Inc. and TIAA-CREF, the huge teachers' pension fund. Vanguard Group Inc., the nation's second-largest fund family, directs any rebates directly to its funds.
Ideally, soft dollars should be banished. William A. McIntosh, former head of fixed-income at Salomon Brothers Inc., says flatly that "the practice itself is an abuse." Politically, though, an outright ban is a nonstarter. It would require legislation, and the current Republican-controlled Congress has little appetite for wiping out a $1 billion industry.
A more realistic goal would be for the SEC to tighten the safe harbor definition, prohibiting the use of soft dollars to pay for anything that's available for cash. That would wipe out rebates for such overhead as computers.
Finally, the SEC should enact tough disclosure rules. Under pressure from a welter of conflicting interests, the agency recently backed away even from a proposed wishy-washy measure. Levitt should be true to his rhetoric; he should require that managers disclose every soft-dollar item or service, itemized by each broker, and the cash value. That would catch the attention of investors, who might well demand that they get an opportunity to enjoy more of the benefits of the soft-dollar gravy train.