However, Investorside has been a fierce proponent of any narrowing of Section 28(e), a possible move now under review. Some members of Congress, with the support of John Bogle, the founder of the Vanguard Group, have called for the reduction or the elimination of the soft dollars. Investorside, in letters to the SEC, has warned that reducing or eliminating soft dollars through the repeal of Section 28(e) would destroy some of the nascent independents.
That would "defund the independent research industry almost completely, and perversely grant a de-facto government preference for conflicted, company subsidized, investment banking research," declares a letter sent by Investorside officials to the SEC. "Just talk of eliminating the primary source of independent research has had the unintended destructive and chilling effect on the use of and investment in independent research," the letter warned.
So why the misunderstanding, even when regulators are now seeking to nurture an independent research industry? It is because independent research remains a little-understood niche business, Cleland says. And that‚s even though these independents are supposedly going to become the solution to the problems of biased research and the resulting scandals of the past few years. These independents are not yet a huge factor. They are now only generating about $500 million in annual revenues, Investorside estimates.
Still, they have become a useful service for some advisors.
Mindy Ying, an advisor with her own firm, PacWest Financial Management in San Marino, Calif., says she chooses from an expanding menu of independent research firms.
"We now depend on these firms to back up the models we are creating in house," she says. "We started using them some years ago and now we have become dependent on them, although we are constantly evaluating them and will often switch services," says Ying. She works with high-net-worth individuals, endowments and offshore accounts.
Grace, who has used an independent firm for the last three years, calls upon the independents to investigate the macroeconomic implication of the recommendations that his firm makes. "Some clients think their planning goals are the only thing they have to worry about. I used a research service to explain to them that there are other things that we need to consider in our plan," Grace says.
"The research firm is more adept than we are at questioning and figuring out where the economy is going. We need to know if the wind is at our backs. This is a way of reassuring clients that every relevant question has been asked and answered about a plan. It is also an important element in getting people to stay with a plan," Grace adds.
Soft Dollars Defined
What are soft dollars? According to The Barron‚s Finance and Investment Handbook, they are "the paying of brokerage firms for their services through commission revenue, rather than through direct payments, known as hard dollar fees."
Ted Aronson, a principal of Aronson+Johnson+ Oritz, a Philadelphia institutional investment advisor, offers a simple definition. "Soft dollars are any commissions that are not used to achieve best execution." Nevertheless, there is a Catch 22 to Aronson‚s explanation. "No one knows how to define best execution," he concedes.