ICI Urges Soft Dollar, Directed Brokerage Reform

December 15, 2003 (PLANSPONSOR.com) - A mutual fund trade group on Monday called on securities regulators to crack down on the use of soft dollars and directed brokerage transactions, which it said could create fund manager conflicts of interest.

By calling on the US Securities and Exchange Commission (SEC) to institute soft-dollar and directed brokerage reforms, the Investment Company Institute (ICI) said it wants to change the relationship between fund companies ad the brokerages executing their buy and sell orders and marketing their funds. Specifically, ICI wants the SEC to “dramatically” curtail the use of soft dollars by investment advisors (including fund managers) and to ban fund use of directed brokerage outright.

ICI President Matthew Fink said in a statement that the actions reinforce mutual funds’ “commitment to putting the interests of fund investors above everything else.” According to Fink, “the ICI Board has been concerned about how these practices were evolving and whether existing regulations remained adequate.”

Directed brokerage, while subject to strict regulations, permit fund companies to consider that a brokerage sells their mutual funds when “directing” orders to a broker. The ICI said the practice raises questions about whether fund managers’ trading decisions are swayed by considerations other than shareholders’ best interests. “If the SEC were to abolish directed brokerage, as the ICI suggests, a significant potential conflict of interest would not just be regulated, it would be eliminated,” the group said in the statement.

Soft Dollar Problems

In the second area of suggested reform, soft dollars award money managers credits from the commissions paid to brokerages when they buy and sell securities. Managers can use these “soft” credits in lieu of “hard” dollars to buy investment research products and other services.

The ICI called for the SEC to significantly curtail the research that can be acquired with soft dollars. Virtually all research products and services that are otherwise available should be sliced out of the SEC’s realm of permitted research. “The current (research) definition is overly expansive,” Fink said, “and thus has been susceptible to abuse. For example, soft dollars can currently be used for routine expenses like computers, software and investment publications. The ICI is convinced a much narrower definition will help eliminate the potential abuses most often associated with the questionable use of soft dollars.”

Not only that, but ICI urged the SEC to bar all investment advisors, including fund managers, from using soft dollars to get any research products and services from third parties. Eliminating this soft dollar outlet “would forcefully address an area that some believe has been most prone to problematic conflicts,” the ICI said.

While a special 1998 SEC inspection sweep found no soft dollar abuses by mutual funds in this area,ICI Chairman Paul Haagapointed out that “questions about the appropriateness of using soft dollars for third party research have cast a pall over all investment advisers, no matter what they actually do in practice.”

The Institute urged the SEC to limit the use of soft dollars to the narrow category of proprietary research that reflects unique intellectual content.   Haaga said. Most research should be paid for from management fees, and not from shareholders’ assets through commissions, he said. “These are substantial reforms,” saidHaagasaid in the statement. If enacted, they “will benefit fund investors by substantially diminishing potential conflicts of interest and strengthening the operating integrity of mutual funds.”

The ICI’s reform call comes as a state and federal probe into fund trading abuses – market timing and late trading – continues to sweep across the financial services industry.

For more information, go to http://www.ici.org/statements/nr/03_news_soft.html .