Two practices that have come under particular scrutiny
from regulators are so-called soft dollar and directed brokerage
arrangements.
Soft dollars
Soft dollars refer to an arrangement in which fund advisers direct fund
trades through a particular broker in exchange for research and other
brokerage services. While proponents say that soft dollars offer
benefits to investors — giving small fund advisers access to valuable
research and strengthening the competitiveness and price efficiency of
small mutual funds — others decry the lack of transparency and oversight
in soft dollar arrangements. Soft dollars, critics say, can also create
conflicts of interest for fund managers, since they may be motivated
to select brokers based on their research and other services rather
than on the speed or price of trade execution for fund transactions.
While soft dollars continue to be legal, regulators are looking at a number
of ways of improving disclosure and protecting investors from potential
conflicts of interest. Among these are stronger oversight by mutual fund
boards of directors and narrowing the scope of services that can be paid
for with soft dollars.
Directed brokerage
The
SEC
recently banned one form of the practice known as directed brokerage
because it could create conflicts of interest for mutual fund managers.
In directed brokerage arrangements, fund managers would direct portfolio
transactions to particular brokerage firms in exchange for promoting their funds.
Many in the industry felt that directed brokerage could be detrimental to
mutual fund shareholders, since it had the potential to create incentives
for fund managers to direct fund transactions to brokers who were
encouraging sales of their funds rather than to the firms that could provide
the best execution, or price, on fund transactions.
Directed brokerage
