Investment Dealers' Digest

Big Changes Afoot for Indie Research Payment

Avital Louria HahnDenise Lugo Avital

The system of compensating independent research shops is in a state of flux. Some battle-hardened research boutiques-especially those with no trading desks to plead their case to buy-side clients-are now insisting on cash up front, or an agreement to pay a preset amount in soft dollars, before buysiders get to see the goods.

"If a client can't agree to a fixed price-either cash or soft dollars-we will no longer do a deal with them," said Brian Overstreet, president and chief executive of San Diego-based Sagient Research Systems.

To understand how matters reached this state of affairs, a little background is necessary. Large buy-side firms like Fidelity Investments, for instance, typically pay their research providers with soft dollars, or trading commissions. Fidelity decides how much to shell out by asking its own money managers and traders to vote on how much value they got from the research. That can be bad news indeed for a small research boutique, which has already informed the fund manager that it requires a certain level of payment for the research. But based on the results of the voting, Fidelity may decide to shell out far, far less than the amount requested. Indeed, some small boutiques have found themselves giving large firms the equivalent of a free subscription to their research.

Those without trading desks have been especially disadvantaged. They lack traders who can communicate with buy-side traders, and plead the case for the value of their research.

As a result, research boutiques in a sufficiently strong position to dictate their own terms are now demanding upfront dollars or a soft-dollar agreement before turning over their research. If neither is forthcoming, some firms will even walk away from the business, Overstreet said.

Overstreet said that his firm's policy is based on its own experience. When the final vote was left to the discretion of the buy-side firm, he said, payments were lower than expected.

"If the people on the buy side believe the research has some validity, they will allocate a commission to the analyst who is providing the information," said Richard Bove, an analyst at Punk Ziegel & Co., an investment banking boutique. "And what happens is that everybody gets to have input in the process."

Including the trading desk. "The traders really have a great deal of say concerning how the commission pool is paid out," Bove added. "So if you don't have traders, you can't collect what you are owed."

All this is occurring just as big buy-side firms like Fidelity are trying to cut trading costs and increase efficiencies. They are cutting the number of firms they trade with, and trying to chop commissions of those who survive the cut.

These large firms pay their research providers almost exclusively via soft dollar arrangements. When a small boutique does not have a trading desk, the buy side will ask a larger, bulge-bracket firm it trades with to cut a check to a smaller boutique. That arrangement is called a "step out," said Rick Wayman, a partner at, an independent research firm.

"If an independent research firm doesn't have a trading desk to receive those commissions, then you have to fall back on the step outs or a hard check," he said, adding that the buy side doesn't like to issue hard checks. With the soft-dollar system mostly dependent on votes, Wayman said that he, too, refuses to provide research to the large firms and then wait to see how much they will pay. Agreeing to their terms, he said, is akin to giving them "a free subscription for six months and not getting paid for it."

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