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Wednesday, July 12, 2006

A Hard Look at Soft Dollars

Reported by Marie Glancy

As the Securities and Exchange Commission goes into action mode on its soft dollar rules, the newly appointed vice president of a California-based "vertical search" company believes increased scrutiny on these payments is teaching the investment management industry a very important lesson: the research they're getting may not be worth much.

David Frankel recently became vice president of financial services at firstRain, a Foster City, California-based provider of research services that counts John Hancock and JP Morgan Asset Management among its clients.

While firstRain caters primarily to institutional investors and hedge funds, its holistic approach to evaluating companies' "ecosystems" may be of interest to any investment professional who is indeed re-thinking the use of soft dollars. The SEC is scheduled to vote Wednesday on a proposal spelling out its rules on soft dollar arrangements, and Dow Jones Newswires reported Tuesday that several Wall Street firms have petitioned the Commission not to ban payments for legitimate brokerage and research services.

But just because fees are going towards actual research doesn't mean they're serving investors well, according to Frankel. Transparency and un-bundling have shown how much cash is actually going towards execution and research, he told the MFWire. "[Fund companies] are seeing the cost of execution is minimal. It's like half a penny ... the reality is that the research isn't that good," he said. As a result, he continued, "All investment managers are more carefully scrutinizing the value they get for soft dollars."

Frankel, who most recently was vice president of sales at Bank of New York's independent research consultancy division, BNY Jaywalk, describes firstRain's method as "digging deep into a company and really understanding all the touchpoints around a company; the term we use is 'ecosystem,' " he said. "We look deeper at a company: its product line, supply chain, regulatory issues, geographic issues."

For example, he said, a client interested in the oil and gas industry might be interested in ethanol issues, such as a particular company's method of ethanol creation. To address this concern, "You need to know who is producing ethanol, the key factors involved in producing ethanol ... we'd be able to pull information about Arthur Daniels Midland and what they're doing in that area; companies in Brazil; legal and regulatory issues with regard to the export of ethanol from Brazil, and how does that occur."

Using a combination of industry knowledge and technological tools, firstRain will "go out and trawl ... to give you the hard-to-find nuggets of information," he said.

Charged with overseeing the growth of firstRain's business for the financial services market, Frankel is planning to add "ecosystems" for a larger number of companies. "There's a huge need for primary sources of information," he maintains. "For the last year or so, there has been a build-up of clients in this space."

Frankel counts mutual fund companies among those he sees looking for better value in research. "We're really delivering the kind of information that these people need to generate alpha," he said. "A service like firstRain will really give [investment] companies a leg up."  

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