Regulatory Concerns Clip Soft Dollar Commissions

May 27, 2004 ( - The use of "soft dollars" by United States investment managers fell 18% last year to $1.24 billion as investment managers cut back on their use of this funding source for third-party research in the face of near certain regulatory intervention.

With last year’s cutback, soft dollars only comprised 11% of overall equity commissions, according to research conducted by Greenwich Associates.   Greenwich says the trend is indicative of the future of soft dollar commission as investment managers anticipate greater regulatory involvement in the space.  

“The declines in soft-dollar usage reflect the expectation that in the current environment, soft dollars are unlikely to escape regulatory action,” says Greenwich Associates consultant John Colon. “As that perception takes hold, we expect to see even deeper cuts in the future, either in the form of across-the-board reductions in soft-dollar usage, or in a paring back of the types of research and services purchased with soft dollars.”

Also down were the premiums paid on soft-dollar trades versus straight NYSE and conversion ratios — the amount of soft commissions required to cover the specific hard-dollar amount of services purchased – fell to 1.44 this year from 1.5 in 2002.   Greenwich Associates found the average commission rate reported by institutions on soft-dollar trades fell to 4.9 cents per share in 2004 from 5.1 cents last year and 5.6 cents in 2002. Comparatively, gross commission rates for straight NYSE agency trades averaged 4.7 cents in 2004.

Money managers are now looking for new methods to obtain funding for third-party equity research and related services in the event of new restrictions or an outright ban on soft dollars, but do not want to consider the use of hard dollars to buy such services.   Greenwich Associates found approximately half of institutions interviewed are “opposed to” or “strongly opposed to” paying hard dollars for access to research and research services.

Thus, Greenwich Associates asks regulators to take into account the possible implications of new soft-dollar regulations on the potential shifts to the availability, quality, and price of equity research, especially as any shift will disproportionately affect third-party providers of research.

“A ban on soft-dollar transactions might reduce trading costs, but it will also affect the production and distribution of the equity research that informs the investment decisions of fund managers,” explains Jay Bennett. “An alternative approach focused on enhancing transparency will ensure that we don’t toss the baby with the bath water.”