Soft dollars are a means of paying brokerage firms for their services through commission revenue, as opposed to normal payments.
According to a study by Greenwich Associates, soft-dollar expenditures among US institutions fell by 10 per cent between Q1 2004 and Q1 2005.
“US institutions are adopting a more conservative approach when it comes to paying for brokerage research and services with soft dollars,” said Jay Bennet, consultant at Greenwich Associates. However, he added, since the SEC has taken longer than expected many firms have decided to wait for the regulator’s final decision before making further changes to their business practices.
Ambiguity about the SEC definition of research and services qualifying for soft-dollar payments makes it difficult for institutions to ensure their current practices will hold up to regulatory scrutiny. However, according to Greenwich, there is a consensus about certain services that are appropriate for these types of payments. This would include financial market quotes and third-party research produced by vendors and non-broker dealers, and financial databases. Third-party research produced by independent boutiques is also considered appropriate for soft-dollar payments. On the other hand, it will be more difficult to evaluate whether electronic systems that provide market data news will qualify for soft-dollar payments.
The study also shows that hard-dollar payments for research remain unpopular among US institutions which generally prefer to preserve a system whereby research is provided by the sell-side in exchange for commissions. “These institutions should be encouraged by signals suggesting that the SEC is not seeking a soft-dollar ban,” said Mr Bennet.
“However, senior management at these organisations should be prepared to justify current soft-dollar expenditures in an environment of increasing transparency and stricter rules governing disclosure and breakdown of costs for trade execution and research.”
SEC chairman William H. Donaldson recently commented that the best prescription for addressing this issue should be improved disclosure. “I am a firm believer in the value of independent research and in taking any action on the subject of soft dollars we will endeavour to promote a level playing field between independent research and proprietary research,” he said.
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